Even Chancellor Merkel has really no idea if 'Euro' is 'in or out.' Much as Sarkozy and Euro land leaders are unsure how Euro is positioned in their land, to live with this ambiguity is a big problem for the global economy and the banks impending second liquidity crunch.

Without a European equivalent of Bernanke and Fed, Euro's future looks very bleak. The dollar is bid, not because of its fundamentals, but by default as Euro faces an uncertain future.

The structural dichotomy that confronts the Euro runs in the psyche and grain of PIIGS and Northern European citizens. Euro has very little likelihood to survive in its present shape and geographical spread. It is mainly due to the diversity in the home ownership trends of PIIGS and Germans. 

It is one of the most important structural differences that remained hidden when Maastricht convergence criterion was agreed. The habits of PIIGS and Germany have now erupted into a full bleeding rapture. Germans resist granting ECB a package equivalent of TARP, i.e., monetisation of debt or to print money. Without a Fed Reserve kind of massive leverage, ECB hands are tied. They have limited options without such a package, that is to say, to be a lender of last resort.

The principal reason behind German reluctance is that predominantly Germans don't own houses, they lease. Leaseholders are most susceptible to price rises, on the contrary, PIIGS have the highest ownership of housing that is helped by rising prices. Germany is not prepared to sacrifice her tenants and Italians are not willing to forgo their homeowners to deteriorating packages of austerity.

Germany can only help Euro zone, if they allow printing money for the advantage of the PIIGS nations to come out of the big crunch. This will be catastrophic for the tenants in Germany. 

PIIGS led by:
1) Ireland: 83% 
2) Italy: 78% 

sit at the top of Home ownership and have the highest Home ownership in Europe.

German house ownership is 43 percent. The northern Europeans sit at the bottom of the table of Home ownership.

12) Denmark:53% 
13) Netherlands:49% 
14) Germany:43% 

Germans rent inexpensively, and are remunerated well, their productivity fares better than the PIIGS. Hence their goods are well reputed and are reasonably priced.

No wonder PIIGS citizens individually are far more wealthy than Germany's. Tarp-assisted help will eventually lead to a bout of inflation that will reduce their real value of debt and increase prices of their stock. Germans mostly do not enjoy this luxury across the board.

Germany will have to either let Euro go and in that case recapitalise their banks, a price they have to pay for allowing her banks to lend to PIIGS freely, or support the TARP equivalent. Politics demand the latter, common sense demands the former. It is far  cheaper for Germans to recapitalise their banks and take a huge haircut in PIIGS' credit than to commit to an umbilical cord of support that may take decades. 'You cannot make a single currency without economic convergence and economic integration.' 

Latest data:

http://www.nationmaster.com/re d/graph/peo_hom_own-people-hom e-ownership&int=-1&id=OECD&b_m ap=1

Why 'Printing money' politely known as 'Quantitative easing' is a must?

http://iqballatif.newsvine .com/_news/2009/03/06/2512 191-why-printing-money-pol itely-known-as-quantitativ e-easing-is-a-must 

Part II - Response to - 'A debt disaster behind a comic book budget squabble' by FT’s Clive Crook

The world had better start paying attention to the US government’s inability to govern. The prevailing mood over this has been strangely complacent. Six months of the fiscal year gone and only now a ramshackle budget? Government brought to the brink of shutdown over trifling disagreements? Absurd, one thinks, but this is Washington. Do as most Americans do, and regard the pantomime with blithe contempt. In the end, out of sheer exhaustion, the actors do their deals and it is business as usual.

Every ten years, it is decline time prediction period for the United States. Foreign Affairs Josef Joffe wrote a great article ‘The False Prophecy of America's Decline’ in 2009.

The pundits from all over predict the economic demise of the United States. The present budgetary stalemate in the Congress has encouraged more such dire predictions regularly. Yale historian Paul Kennedy in 1980 predicted the ruin of the United States, driven by overextension abroad and profligacy at home. The United States was at a risk of "imperial overstretch," Kennedy wrote in 1987, arguing that "the sum total of the United States' global interests and obligations is nowadays far larger than the country's power to defend them all simultaneously." Within couple of years, US dispatched 600,000 soldiers to fight the first Iraq war -- without reinstating the draft or raising taxes. The only price of "overstretch" turned out to be the mild recession of 1991.

Every ten years, it is decline time in the United States. In the late 1950s, it was the Sputnik shock, followed by the "missile gap" trumpeted by John F. Kennedy in the 1960 presidential campaign. A decade later, Richard Nixon and Henry Kissinger sounded the dirge over bipolarity, predicting a world of five, rather than two, global powers. At the end of the 1970s, Jimmy Carter's "malaise" speech invoked "a crisis of confidence" that struck "at the very heart and soul and spirit of our national will."

This self-defeatist talk took a break in the 1990s. The United States was enjoying a nice run after the fall of the Soviet Union, as was Japan - the miracle predicted for Japan as the new economic powerhouse of the 1980s. It is still stuck in its "lost decade" of stagnation, and all those talks of U.S. paranoia over Japan’s takeover of national treasures such as Pebble Beach and Rockefeller Center are a distant memory. Though China has now replaced Japan with a new kind of supposedly pulling off all Treasury investments threat, yet none of these gurus ever find an answer to what China is going to do with its $3 trillion reserves.

From those dire predictions of the 80's malaise and 90's imperial overstretch, the United States had moved into the longest economic expansion in history, which, apart from eight down months in 2001, continued until 2008. The turncoat professional experts changed the color of their economic predictions in no time. In the early 2000's we heard "Gloom is the dominant mood in Japan these days," whereas American capitalism was reported as “resurgent, confident and brash.” That year, the New York Times columnist Thomas Friedman wrote that "the defining feature of world affairs" was "globalization" and that if "you had to design a country best suited to compete in such a world, [it would be] today's America." He concluded on a triumphant note: "Globalization is us."

USA will come out of these dire predictions of bankruptcy. If US$ suffers so will Oil and Gold, the trading currency of these two base commodities is the dollar. Global oil supplies are balanced as a result of that so-called extended defense budget. The economic prosperity of the world owes a lot to US presence and the proximity of a big stick to all the narrow sea lanes like Hormuz and Red Sea.

US consumerism provides the cannon fodder to Chinese export surpluses and in turn helps Chinese to buy the US debt. Someone’s debt is another’s saving, global finances are precariously managed by those who have credits, they don't have to read dire predictions every day, they know that to maintain this precarious global balance of trade and economic prosperity and to shift the billions of have-nots to haves, someone has to carry the burden of insatiable consumerism. Hype and overextension is an art of the whole new game of economic prosperity.

The fragile balance of peace in the 'Strait of Hormuz' is maintained by the Bahrain-based US fleet. Take these elements out and the world will become an inhospitable place for trade and commerce. It is in the interest of the Chinese, the Russians and the Europeans to maintain US economic power as a bulwark against totalitarianism of the political strains of ideological expansionism. That is what USA and its debt is all about. The 'global warlords' are in check by this ‘imperial overstretch.’ This is the main reason that the every-decade prognostications of US disaster fall on their face.

Part I: Response to "Faltering in a stormy sea of debt"

Part I - A response to Martin Wolf’s article on FT: 'Faltering in a stormy sea of debt'

In all, policymakers confront a host of complex and interlocking challenges: fiscal and monetary normalisation in advanced countries; fixing the overhang of excess debt and financial fragility in those economies; managing the overheating in emerging economies; adjusting to big shifts in relative prices; and rebalancing the entire pattern of global demand. Nothing that is now happening suggests any of this will be managed competently, let alone smoothly. In short, those who think we are now looking at the sunlit uplands are fooling themselves. Much disruption lies ahead.

Global GDP in 1960 was 1.6 trillion dollars; it rose in 1990 to 30 trillion dollars, and nearly doubled to $60 trillion in 2009 even after the crisis. A healthy GDP-to-debt ratio based on convergence criterion of Maastricht treaty would be 60% - $36 trillion.

The huge hockey like growth of global GDP is an unprecedented event in human history and so is the associated global prosperity.

2.5 billion Chinese and Indians broke the Mao/Hindu growth rate and joined the global elite under the banner of BRICS, so did Stalinist totalitarian Russia and rich countries like Brazil and other peripheral countries. We keep complaining about debt, but global GDP would not have grown had it not been for the leverage. Poverty in Africa is rampant, but inward investments have started, so this was not a useless rise of debt as it was associated with real unparalleled growth of global GDP.

When we talk of the debt burden built up over the last 50 years, which has affected economies from Florida to Iceland, we forget that in the crisis lies the solution for global mass poverty, otherwise what chance did the lowest segment of the world have without this huge move forward? Debt-to-GDP ratios plus the relationship between the yield on their debt and economic growth have to be studied beyond the concept of economics.

Based on data supplied by the McKinsey Global Institute, yes, debt/GDP ratios have risen rapidly and in the next decade, they may exceed 300% of GDP in Japan; 200% in the United Kingdom; and 150% in Belgium, France, Ireland, Greece, Italy and the United States. It is clear from the slope of the line that without a change in policy the path is unstable. This is confirmed by the projected interest rate paths, again in our baseline scenario. From around 5% today, these numbers rise to over 10% in all cases, and as high as 27% in the United Kingdom.

GDP growth rates have helped per-capita incomes and increased prospective customers all around. If 7 billion people of the earth can be helped with average growth of income from 8,000 to say 12,000 over the next five years, this increase will take care of global debt.

World 8,200
Low income 2,190
Middle income 6,000
Lower middle income 5,510
Upper middle income 9,900
Low & middle income 4,320
East Asia & Pacific 4,680
Europe & Central Asia 7,570
Latin America & Caribbean 7,080
Middle East & North Africa 5,700
South Asia 2,660
Sub-Saharan Africa 1,770
High income 29,480
European Monetary Union 26,260

To keep stable interest rates and help the world economically grow and avoid implosion of their own economies those with $3 trillion reserves like China will have to go on a shopping spree and buy the debt of the indebted world to keep the global economy from implosion.

This is exactly what they are doing, keeping the US dollar stable because in a stable dollar lies the stability of global trade and business growth.

Read Part II here

Political ramifications of inaction are disastrous. The health of any economy is directly proportional to the ability of its leaders to take actions. Inaction and status quo is a sign of wakened and hesitant. When one is faced with a challenge the only way forward is to face it and address it. These are the points we raised at the highest levels and various meetings and seminars that I was invited too. I welcome that these were published in the largest paper of Kuwait today. (1)

1.Economic reality in today's world dictates that there has to be a political consensus if an economic meltdown is to be averted.

2.One does not need to be a rocket scientist to see that Kuwaiti economy is in a stalemate and growth has frozen completely. With oil at $70+ and Kuwaiti investments outside Kuwait running at an all-time high it is sad to see that domestic issues which need immediate answers are being delayed. Politicization of economic decision making process is taking the country towards an economic meltdown.

3.Market capitalization in Kuwait is a key indicator. The entire lending structure of Kuwaiti banks and the private sector is secured by companies that are listed on the Kuwaiti stock exchange. As a result of the lack of decision-making, the companies' market capitalization is being devoured; therefore, most of the private sector companies are suffering from margin calls made by the bank. The ability of private companies to raise money has completely dried. The banks are not lending because they are holding on to their high cash deposits. They are worried about a market meltdown. If one looks at mark to market closely, there is a serious risk that banks' market capitalization can be significantly eroded if three of the major companies like Zain, National Bank, and Kuwait Finance House, continue to slide.

4.The question we need to ask is: is it worth letting Zain, NBK, and other companies to slide because we want to achieve political point-scoring. Inaction to save market from complete meltdown is to be found by the government taking major stakes in the private companies – these are perfectly well run companies; the erosion of their market capitalization is a result of their expansion into world derivative markets, and a fallout from global recession. We can wait and see, and continue to play the game of watching who suffers from this meltdown, but what would be the result? We all know that notables from the private sector will be heavily suffering from this inaction, but there has to be a political will now. Inaction will result into much bigger problems later on because these assets can lead to banks being illiquid; if the Kuwaiti market continues to slide, we may see that many of the middle class Kuwaitis who invested their life savings in the stock market may then require a much bigger package.

5.At the end of the day, if market slides occur and a Gulf Bank kind of situation arises, then institutions will have to be bailed out, and the bill will be far bigger. Our economy is now unfortunately hostage to political bickering. Here the situation is to think about the country before individuals. There is no need to help an individual, but there is a need to help the state. And the help of state will only come if instead of employing hundreds of billions of dollars of Future General Funds into foreign markets, we may apply our attention to the local market and address the causes of this uncertainty.

6.The uncertainty of decision making is the real cancer in the society. Politicians and the government have to decide that letting it linger on is killing the growth of economy. Growth has stagnated. Without growth, the construction sector, all these big buildings and Manhattan-like skyline will halt to a naught. Imagine a default on these construction loans as a result of stagnation in growth, because growth provides the engine where the companies feel confidence to take space, and grow their businesses. In our opinion, inaction now can be linked to what ex-US Treasury secretary Henry Paulson failed to comprehend. His decision not to help Lehman Brothers due to personal differences with the Chairman of the Board, was considered to be a horrendous decision. The world is still licking the wounds of Lehman bankruptcy. Within a month of Lehman's bankruptcy, Merrill Lynch was taken over by Bank of America, Fed bailed out AIG for 85 billion dollars, Lloyds had to buy HBOS, WAMU was closed; European governments within 15 days scrambled to shore up the banks; US had to agree on a bailout package in excess of a trillion dollars and Britain had to inject hundreds of billions of pounds into the banking sector, and US Treasury had to inject 250 billion dollars to exchange for preferred shares.

7.Lehman was a lynchpin. Once the confidence in the banking sector eroded and the world came to know, the meltdown began. And that cost is around 2-3 trillion dollars in the OECD economy. Hank Paulson was asked and privately he has reported that without letting Lehman go bankrupt, there was no political will. Now for Kuwait we have to understand it is not a matter of individuals, there has to be a political consensus established to save the economy of Kuwait. It's a joke that a country with such a huge reserve of foreign exchange that is being utilized by the entire world is facing a domestic meltdown. We are saving the world's financial institutions and putting our own in peril because someone wants to punish and settle old scores. This mentality has to stop. There will be political repercussions if there is a dismantlement of old guards of the business. A strong private sector is reflective of a strong peoples, strong state, and strong institutionalization.

8.It is ironical to ask the state to intervene to save the private sector, but that is what has been happening all over the world. It was under President Bush, a Republican who believed in the private sector, when the biggest interventions were made. On the other side of the coin, Gordon Brown and David Cameron did not object on Gordon Brown taking over Lloyds or HBOS or Barclays. The problem with Kuwait is that the numbers required to stabilize and putting up a bottom for Kuwaiti stock market will give confidence to people not to panic sell. Panic selling causes loan to value ratios deteriorating. A real estate company whose shares are being utilized as collateral to the bank, faces liquidation because of the fact because unrelated panic in the market causes its shares to go below the limit where bank demands more assets and more liquidity. So this creates a domino effect.

9.Enough punishment has been meted out to players who have been aggressive and greedy. Here further economic decline will cause demographic polarization, social unrest, and eventually a mass package. Do we need to do that? Do we need to create this kind of polarization because we do not have the ability to take decisions and establish a political consensus between punishing the excesses and saving the institutions. We should be proud of our private sector, which will create jobs, it will be the major cause for economic revival. Without growth no state can prosper. State cannot provide jobs for every Kuwaiti; the private sector will have to be active. We are failing the private sector by the hemorrhaging we are causing to them. We will become hostage to demands of those who think that the only answer to Kuwaiti problems is to distribute the wealth and create an egalitarian society based on consumption, consumption, consumption.

10.Private sector has helped incorporation of technological advances in Kuwait, in the field of oil, construction, software, Kuwaiti companies are at a leading edge. The transformation of Kuwait from a desert land to a vibrant economy that has one of the best construction sectors building high rises and tallest buildings, and the best highways, it needs aptitude. Institutions that were relatively saved from the world meltdown, the burning question now is: should we kill the private sector? Let's not take revenge on the private sector because we are being short-termists. Kuwait will be stronger when our private sector is stronger; Kuwait will be stronger when incentives work hard; it's not an evil to help the private sector. If Gordon Brown, Bush and Obama who are from completely different political backgrounds, can do it, we should do it. There is no other answer. The liquidity in the system has disappeared. The banks' capitalization has become hostage to continuous meltdown and threats to the markets.

11.Answers will not come from our old friends, answers will come from within; answers do not lie in selling Kuwaiti assets to foreigners. Answers lie in that the assets be taken over, like they have been done in UK and USA, for future generations. Whenever the Kuwaiti government has intervened in panic situations, the state has always benefited. Panic creates opportunities. This is an opportunity for the state to make good investment for the future generation of Kuwaitis, and take stakes in well managed Kuwaiti companies and put the Kuwaiti economy back on track of growth. Once the economy grows, all wounds will heal and all these empty towers will fill up, and all our children looking for jobs will find jobs in the private sector. In this connected world, this is the call of the day. We should not let the lesson of Lehman Brothers go to waste. We should learn from what happened in the world. Let's see and have an open debate, and the real grilling should be on the merits of state intervention or not. Unfortunately this is a subject nobody is talking about.

12.Punishing the private sector and its leaders will only make Kuwait weak. The total banking exposure in the market is US$52-55 billion. This exposure determines the state of the banks' capitalization. If a bottom is taken out of the market, the first thing hit would be the banks' equity. The biggest problem is that once the system collapses, you have to have a debtors' program and maybe as large, if not larger, than the one post-Manakh crisis back in the 1980s.The crisis of confidence can only be overcome by the confidence in economy, the system and the private sector - that is the only way.

http://www.alqabas.com.kw/Article.aspx?id=548454&date=09112009

Li- Honey, I shrunk the global assets by 40 trillion$'s and still counting!!( the author of 'Gaussian copula function.')

Wall Street turned to the quants—brainy financial engineers—to invent new ways to boost profits. Their methods for minting money worked brilliantly... until one of them devastated the global economy.

One question haunts me on all dinner tables, from political leaders to bankers the quest of the holy grail of missing trillions remains unanswered, where has the money gone, I usually reply with a little condor that the money was actually not there at the first place, valuations are illusory meltdowns are real.

The trail of the missing trillions is a short story of where has the money gone from the global monetary system. One needs to understand what has happened to the 'money' in the system.Valuations are based on 'human design' except when they wear down the monies lost are someone savings; one must never forget that assets are sum total of equity and liabilities, when asset valuation is below the total liabilities the negative equity is actually the disappearance of savings. The insolvency of global financial system is rapture of confidence and savings it can only be repaired by pro active injection of the missing link i.e. cash.

When we say evaporation of asset bubble from 65 trillion $'s to 25 trillion $'s, the amount of money that has disappeared from the global asset base is around 40 trillion $'s.

Say we assume safe 30/70 loan to equity ratio, on that conjecture at the top of the market the global asset base of 65 trillion constituted of equity of 19.5 trillion and 45.5 trillion of bank loans. Today global assets after meltdown stand at 25 trillion, the equity has just been wiped out and global loans against these assets still stand at 45 trillion with a market valuation of 25 trillion, this represents a negative equity for the lenders of 20 trillion, market like a pendulum swings between' irrational exuberance' on one extreme and 'irrational gloom' on the other end.

The write down of the valuation has been ruthless and one sided, market tend to behave irrationally the extremes and volatility that we see today is unprecedented and will subside if confidence returns similar to oil which did not belong at 150$ a barrel nor does it belong to 30$ where the markets expect it to be.
(Inflation adjusted we have never seen oil so cheap in recent years)

If P/E ratios at an average of 21 were excessive, low P/E ratios today invite investor's enthusiasm; based on these low valuations and negative equity for the 'global lenders' of 20 trillion we see global asset holders owing to the lenders monies far greater than what they are worth. If the global assets in good times were making 4 trillion in profits today in bad times they still make 3 trillion, at 12 times earnings they are worth around 36 trillion far in excess of what market is valuing these assets at 25 trillion.

Four trillion in profit decline to 3 trillion might be the optimist view point; a lot of nay sayers are actually saying losses will be much greater. Xover, which calculates default rates for corporate debt assumes at current levels, 35% of firm will go into bankruptcy.

We cannot have equity at zero and no impact on loans, equity is correcting as credit market has already written down most of the assets (ABS, CMBS and CDO's)

This equation of mass meltdown, negative equity on one hand and strong consumerism and global spending on the other do not balance. Global burden has to be written down or debt monetized, short of that we will see mass bankruptcies leading to actual impact on real economy. Global trade will collapse and nations will economically and politically ruin. The markets have taken care of reduction of debt by marking the corporate and sovereign bonds far below par, leaving USA, UK and other stable economies untouched. The issue if moral hazard is also taken care by the markets by wiping out of the banks equities. ( citi trading below 1$)

The flight to quality and flight to $ indicates that market believes that treasuries can help and stimulus is required as an antidote to the poison of asset bubble. Market is the best barometric it is therefore treating the US treasury and even Gilts with respect, as a best referee the 'markets' are telling the government to stave off the crisis by instituting the element that is missing in this equation, the element of cash.

Quantitative easing provides one such avenue, money has disappeared as a result of correction in valuation, the written down assets have no markets since there is no cash around, the excessive swing of the markets and writing down of assets have brought values of real assets to a historical low, I see that few trillion $'s of global quantitative easing will help grease the system and bring some stability back.

If the global economy will not be stabilized after all these measure the first sign would be flight from US treasury and collapse of major currency majors with onset of mass inflation, presently staying cash would mean no return as interest rates hover around zero. One sign of mass despair and gloom is that you talk to anyone and they will tell you stay cash, but that is a self defeating obsession. The logic is that assets will be cheaper, perhaps as the world collapses the first hit will be the paper currencies, cash will be the first casualty as world will enter into a more barter like trading system.

Hopefully global assets will eventually stabilize with a great deal of injection of money, these stimulus packages will work, one should own assets and hedge the bets if we fail the cash anyway will be hit if we succeed assets will be much more dearer, in absence of gold standard paper currency is worth the IOU of the sovereign backing it, today US and UK are trusted by the markets as sovereigns that take their economies out of the crisis, lets trust the markets they are the best indicators, yes my mind will change when US treasury trades at a discount the part will be over then jump into Gold.

Here's what killed your 401(k) David X. Li's Gaussian copula function as first published in 2000. Investors exploited it as a quick—and fatally flawed—way to assess risk. A shorter version appears on this month's cover of Wired.

In the world of finance, too many quants see only the numbers before them and forget about the concrete reality the figures are supposed to represent. They think they can model just a few years' worth of data and come up with probabilities for things that may happen only once every 10,000 years. Then people invest on the basis of those probabilities, without stopping to wonder whether the numbers make any sense at all.

PREAMBLE

The government and regulators' decision to keep the Karachi stock market glued to the 'floor' of 9,144 points in its 100-share index from Aug 27th, 2008 until yesterday have broken the backs of brokers and investors. The Pakistani equity markets were 'floored' until yesterday, it is impossible to find a comparable. Following 9/11, the New York Stock Exchange stopped trade for four days -- its longest closure since 1929. On the onset of Great Depression that crippled US economy the market never closed more than 21 days after Oct 24, 1929, now known as "Black Thursday."

ANALOGY OF TODAY'S PREDICAMENT

When the government and regulators create unpredictable circumstances, the market stands collapsed today. What is at stake today is akin to market players and brokers being farmers who grow their crops and make their livelihood. Imagine a landlord who closes the fields for the whole season and then demands his share of the crops. There are no crops possible. This is the dilemma of the market, of brokers and investors.

BACKGROUND AND REASONS

•This was the top ever and unprecedented 'peace time' shutting of an equity marketplace in the world. The decision was taken by the governments and the regulators, which basically was not in their hands.

•The reason the decision was taken was for the fact that unseen wealth destruction has taken place globally and Pakistan has suffered from this unprecedented wealth destruction.

•No one is realizing that this wealth destruction has put the entire financial system in a liquidity trap.

•The market cap, through a drop of 6,500 points in fewer than four months from April 20 to Aug 27 had lost $ 45 billion in market capitalization. On April 20th market cap stood at $75 billion, today it is at $34-35 billion.

•A further decline of 40% is anticipated where market capitalization will stand at $16-18 billion$. That's a $60 billion loss of wealth! The free float of the market is nearly 30-40% of total market cap, so actually 30-40% of 60 billion has evaporated from the system, i.e., assuming a free float of 30%, that's nearly 18 billion dollars.

The disappearance of the wealth formation of seven years in a span of 6 months cannot be sustained by any financial system in the world, and certainly not a flagellating economy like Pakistan's. The reason for these drops were:

1) Oil prices touching levels of nearly $148;

2) High global commodity inflation (where Pakistan suffered the most);

3) Interest rates had to be increased; and

4) Political instability prevalent in the country from October 2007 to April 2008. Pakistani markets started melting down much before the global meltdown which began later in September 2008.

INTERNATIONAL EXAMPLES

Nowhere in the world have markets ever been closed for four months, although Russian equity markets collapsed after Lehman Brothers' bankruptcy, post 12 September, and there was a closure for a few days. But there was a huge bailout package from the Russian government. The same happened in Kuwait. The market tanked and the court issued an order for markets to remain suspended for a few days, and then the government provided the bailout package. These are two prime examples, Russia and Kuwait, who are oil-rich countries.

Within the OECD countries, we all know about the US bailout package whereby nearly a trillion dollars have been committed to save the financial sector from defaults. UK has taken the lead. These countries that take pride in private ownership have practically taken over the banks, nationalized them, because of their banks' illiquidity. After Bear Stearns and Lehman, equities have been injected in Merrill Lynch where it was thrown into the arms of Bank of America, and Citigroup was injected with $30 billion recently. EU has come up with a package of €250 billion to save banks like SocGen, BNP Paribas and Deutsche Bank from disasters.

•Here in Pakistan markets, when the bottom was taken out, the very reason to put a floor was that the regulators and government had promised some kind of a stabilization fund and for 4 months they kept discussing it.

•Every situation that justifies a force majeure exists in the market – for investor and broker. Force majeure event is justified by four litmus tests in this environment.

•First of all, the externality factor: market closure has nothing to do with the broker and investor, it was the regulator and the government and the whole press knows about the stabilization fund. It was an effort to save the industry, not an individual. And the broker or investor has nothing to do with this externality factor of the force majeure through which the market was closed for four months. It led to the inability of the investor to sell their share at lower cost because open markets would have determined their own level, it would have not led to major defaults.

•By closing it for four months, open markets were turned into closed markets and an artificial support was created to support an artificial price where there were sellers but no buyers. Therefore a curb market developed whereby these very shares in the four months found their own level by trading at a discount of 40-50%.

•In a systematic market, without a four months closure, which, if nothing had to be done, now looks to be the most damaging aspect because the interest of 22% was charged to brokers. They were unable to liquidate their shares in a systematic manner, albeit at a lower price as the drop would have been 5% every day, but they would not have ended up taking the cost of 22% interest plus the illiquidity of their investment.

•The biggest problem the regulators and the government created was the illiquidity of the market. And everyone believes that the marketplace was closed until December for IMF negotiations to be settled. The government and regulators wanted to avoid at every cost the large outflows of funds from their foreign exchange reserves as foreign sellers were selling big.

•To insulate their own FX reserves, they stopped the market, so that foreign sellers would not sell, and hence no pressure on their FX reserves, completed their negotiations with the IMF, and promised IMF there would be no stabilization fund, totally contrary to the reasons why the market was closed for four months.

•All promises were broken on the premise that "IMF has told us not to provide any stabilization fund to the markets." So government and regulators have used the brokers and investors for four months and left them high and dry facing a huge cost of 4 months of illiquidity and financial cost. This is the most injudicious act by the regulators and the government.

•The systematic risk to the market would be much less if the brokers and investors were allowed to continue with their activities soon after 27th August. In 10 sessions, in the worst scenario, a market bottom would have been reached because trades would have been settled, liquidity would be in the system and people would have sold shares, accepted losses and moved on.

•Here after 4 months of creating a market where there are only sellers and no buyers because an artificial floor was created and now that floor has been removed without the promises on which that floor was based in the first place.

•If the government and regulators had intervened and not broken their promises they would not have broken any sacrosanct principles of free market economy. Rather, by closing the market for 4 months, they have created unpredictability, a litmus test for force majeure, because the broker and investor were unprepared for an event – it created broker and investor were unprepared for this kind of closure. And this standard is very strictly applied.

•As we have highlighted, the market players used a system which is a leveraged system. The CFS system is in itself a system of leverage created by the market mechanism over time-tested methods. And the basic condition of the badla system is based on the fact that government and regulators should provide the security and legal ambit in which markets can work without any unpredictability.

(Reference: i) CE 9 April 1962, "Chais d'Armagnac": The Conseil d'Etat adjudged that, since a flood had occurred 69 years before that which caused the damage at issue, the latter flood was predictable. ii) Administrative tribunal of Grenoble, 19 June 1974, "Dame Bosvy": An avalanche was judged to be predictable since it had an antecedent of half a century past).

•The goalposts have been changed by the government and regulators. In absence of a stabilization fund, (like everyone else has done in the world, nobody is a greater free marketeer than Henry Paulson, or that Thatcherism was revised by the takeover of Northern Rock and RBS), Pakistan stands at a crossroads today. This is just the tip of the iceberg. If relief is not provided to the investors and brokers the chances of a meltdown are real and that will encapsulate the entire financial system.

•A landlord who has closed the fields for a whole season should have no right to demand from the farmer the share of the crops. The CFS positions have to be resolved on floor level, and this reneging on the promise, with four months' closure, is the ugliest chapter in the history of free market economy.

•The honourable court should decide that the brokers and investors should not be allowed to be used as pawns for negotiations. The Ministry of Finance was fully aware of the commitments and promises to the brokers and investors, and the press clippings will prove that.

Don't cross a river, which on average is 4 feet deep.

Omar 5:48pm November 13

Banks do not have a handle of the error of forecasting further losses or write downs. It's not like forecasting life expectancy which is a much more forgiving exercise. If you predict that someone lives to the age of 80 your error maybe say + or - 15 years. If that person makes it to 80, your next forecast will have an error of say + or - 7 years. ... The error gets smaller and smaller; it always tends to zero. It's not like someone can live to 1,000 or 1,000,000! On the other hand, the error of forecasting bank losses on toxic assets can be explosive. Provisions of 1 billion can turn to 10 billion! As events in the market and economy unfold, we do not necessarily have a better understanding of the degree of losses. This makes the task of bank recapitalizations and government bail outs a nightmare.

As the saying goes amongst traders: Don't cross a river, which on average is 4 feet deep. With random variables like losses it's the error or deviation from the mean that is more consequential!

Iqbal Latif at 11:28pm November 13

If we would do that << Don't cross a river, which on average is 4 feet deep. >> we will still consider India on the other side of the Atlantic and Earth as heart of the universe, we need to cross all rivers, we need to take risk and therefore we are what we are.

Delusions and overstretch of valuations is part of the capitalistic mechanism of self ... The future Mittal is being made right now under our noses as the one who is slowly and steadily gathering the right assets.

Skeptics and negativity rarely ever creates it is self destructive in nature. By the way I have become a great fan Sextus Empiricus, thanks for the book. Nissim Taleb Black Swans is my favourite too.

http://www.globalpolitician.com/24405-political-theory

<< With random variables like losses its the error or deviation from the mean that is more consequential!>>

''The Black Swan''-Taleb goes way overboard in attributing everything to luck. He thinks Microsoft beat out Apple just due to luck. Taleb does not consider that Microsoft open system allowed it to mushroom while Apple locked itself into a ... Also; according to Taleb both the rise and fall of Rome were due entirely to luck. But, Rome was best at developing military strategy and transportation networks. However, it eventually suffered from imperial overstretch.1

"I see the younger generation [of hedge fund managers] hampered by the need to understand and rationalize why something should go up or down. Usually, by the time that becomes self-evident, the move is already over. When I got into the business, there was so little information on fundamentals, and what little information one could get was largely imperfect. We learned just to go with the chart. Why work when Mr. Market can do it for you? These days, there are many more deep intellectuals in the business, and that, coupled with the explosion of information on the Internet, creates the illusion that there is an explanation for everything... There are young men and women graduating from college who have a tremendous work ethic, but they get lost trying to understand the logic behind a whole variety of market moves. [At the end of a bull market or bear market] there's typically no logic to it; irrationality reigns supreme, and no class can teach you what to do during that brief, volatile, reign."

-- Paul Tudor Jones

Rehan Latif at 9:56am November 14

In Toxic bonds, I would suggest banks have marked these down to close to 0, so the question of unknown loss is redundant, because there is no downside from there. So I think banks have a good handle on that now. The question is the entire bond inventory banks hold. I would say that most of these are performing well, collecting coupons, but the ... issue is if they are marked down to 60 cents, I doubt they would get anywhere close to that level in a dead secondary market, just no bid. Even TARP has had to change their mandate, simply because banks are not willing to sell at distressed levels, healthy bonds. Liquidity is better for most banks, so if they are not willing to hit just any bid, why not sit on positions you understand, collect the coupon and amortization at the discounted cash price. The Toxic issue has been dealt with viciously value down (or lose the bank ala Lehman's) or sell off (e.g., Thain sold Merrill's toxic assets at 16c to the dollar).

Omar responds..
Dear Iqbal: Taleb prefers to be skeptical and cannot say with certainty whether something is due to luck or skill; he does not contribute "everything to luck". He does not say Buffet is lucky, but says he might be; "even a broken clock is right twice a day".

A definition of randomness is important here. In Taleb's analogy of the turkey and the ... Read Morebutcher, it is key to note that for the turkey his slaughter on the eve of Thanks Giving is a Black Swan, but for the butcher it's not. Thus, randomness is synonymous with incomplete information.

I do not think "we need to cross all rivers". Cross the river if you have a handle of your error rate. Many quants and statisticians worryingly do not. Their models are based on Gaussian techniques, which in a world of Black Swans can blow up with destructive repercussions. If you do not have a handle of your error, expose yourself to positive Black Swans. Avoid banking and reinsurance and focus on biotechnology or venture capital.

After a Black Swan event, we tend to look back and say, "You know what, I saw it coming". This is known as "hindsight bias". After WWI, historians said the war was the result of tension between Germany and Austria and the UK, and began to predict tension leads to war. But they ignore all the episodes of tension that did not ... Read Morelead to war. Prior tension typically lead to Kings getting drunk together in Baden-Baden. Also, there was a market called War Bonds, which failed to predict the war.

Thus, I am skeptical that after the event, we attribute Microsoft's success to knowing its open source policy would lead to its monopoly of the computer software market. Further, even if they did know open source would lead to greater market share, I doubt they predicted the magnitude of its effect. Similarly, the current credit crisis is a "Grey Swan". Some commentators saw it coming. But no one predicted its magnitude.

My central problem with "crossing all rivers" is that it goes from what you know to what you don't know. It's not an empirical exercise. It's not scientific.

Zachary Latif

1. Biggest baddest dawg in the street

being me is no mean feat

can we still do a trade please

all you have to do is cut the grease!

Better start now won't charge a fee

brothers sisters listen to me

I know I've been quiet so far

didnt wanna fling the tar

2. I swear I'm quitting the condemnation

I've thought about starting the fornication

Instead listening to market by bush

he got no game got no mercy better tell him to shush

the fed just went into a meeting

I can feel my bones are all heating

Where else to turn these markets

I still wanna to earn those trinkets

It is true I is super posh

Sometimes I do write mush

But wait a bit I'll be down with it

And then I'll be zack-innit

Rehan is shocked, Obama wins and rainbows shot through the bleak London morning and little unicorns started flying around.. Who knew. 6:06am

Rehan Rafay 2:51pm November 7

Rome has a new emperor and Im lovin it!

Rehan Latif at 3:46pm November 7

Thats where you are mistaken young grasshopper... Rome, never had a black emperor, 3 african popes the last one in 450 AD... America have done it within a few generations... The beauty of *real* revolutionary thinking, more than 50% of the US population voted for this change, not you, not any of your fire brand thinkers... Hail the real heroes of ... Read Morethis results, the Americans who have once again showed why they are the greatest nation in the world, by smashing down orthodoxy and contemplating something revolutionary. This WILL never happen in the Islamic world, let alone Europe, such a volte face in less than a decade. Its the sign of a Nation still in its ascendancy, that they can self analyse and accept dramatic change. Its up to some of us now to re asses our own views and prove that we can also accept change this quickly.... They talk about the Rise and Fall of Rome but there is no precedence for the United States. It stands alone as the greatest civilization has to offer for now...

Rehan Rafay 4:07pm November 7

Since I'm too young to be cynical...I'm starting a "real revolutionary" movement in Makran just to prove u wrong and also recommending u for a job in Dept of Home Land Security in the new Obama administration...America needs patriots like u!

I've been very troubled this week because I expected the great recession/depression event to really culminate some time next year whence then we'd start our recovery. However the economic data emerging from the US this week is currently pointing to a severe ongoing recession with ISM at record lows (indicating a 1% yoy decline in GDP), ADP & NFP numbers at lvls consistent with a severe recession (this time ADP numbers proving to be a reliable signal for NFP) and now it seems that US unemployment is at a 14-yr-high of 6.5%. In the last recession we only saw unemployment peak to 6.3% however expect US unemployment to edge up to high as 8.5% next yr..

I may be a hopeless optimist but all is not doom & gloom; these statistics are actually arming the central banks and the govts to actively take on interventionist roles. The quicker the contraction and collapses pulls back the date for the eventual recovery as well; the only fear is that whether this contraction will be so deep so as to precipitate a general economic depression but I dismiss that possibility. This is the twilight zone as I see opinions & expectations of all those around me (incl. myself) change dramatically as events unfold (or rather collapse). The market has no expectations or credibility in a crisis of this magnitude- name me one analyst who would have thought that King & Brown would lead the world in stemming global economic collapse. As an aside Prime Minister I heartily congratulate you on winning this latest by-election (in Scotland of all places!) and expect you to trounce the Tory party in the next general election. A natural Tory, by instinct and sentiment, I'm finding myself drawn by the pragmatism and activism of New Labour; that's what economic malaise does to one I guess..

We traders slavishly follow our research analysts; for all the outcry about the end of dotcom dependence on analyst, markets still rise & fall on whether or not estimates earnings beat expectations. Our analysts have failed once again by not actually admitting that they've been out of their depth and that this economic situation can't simply explain by transposing graphs from the 70's or early 80's recession but that this unprecedented of prosperity (global growth has averaged 6% in this new millenium) will have hiccups on the way. I didn't know about an Obama bounce until Wednesday; last week & Monday I assumed there was a rally on expectations of future rate cuts. It seems however the Obama bounce was fictional and that the market, in this session, is actually rallying on those very dismal and poor economic figures with the expectation that rates are actually going to go all the way down to 0. Sometimes the more things change the more they stay the same.

The bob in the title refers to the nickname for the sterling. I've pulled back my ordinary zw release because of the triumphant and deftly unexpected moves by King to cut 150bps. It shows that central bankers are understanding that in this crisis the race is to 0% rates and negative real rates. It's brilliant this is the first morning that I told myself "Zack stop the unorthodoxy"; read the research go with consensus.

I duly chose 50bps as my standard for both rate cuts because I thought that was what the market was pricing in and this time I decided to follow the market. I did all my research, read the dismal news and studied the dismal charts. I am now more convinced than ever that these stimulus measures are going to result in a V-Shaped recovery; at 3% this is the lowest rate that the boe has ever been since 1954 and only another cut (1%) away from their all-time lows at 2%. Understand the magnitude of this cut, which means that we are going to drop as a result of this crisis to a record low of 1% next year.

Why did cable rally on the back of the cut when it should be plunging. That's because in this mkt USD is the risk-averse currency. Flight to quality USD flight to risk any other currency. To prove this hypothese I'd go long GBPUSD (cable) at (1.5937) and short EURUSD at (1.2806). I'm off for a yummy lunch; soup now that my mother has put me on this strict diet (I did manage to clean off my 3/4 krispy kreme donuts this morning; I really have no shame).

KK out
so sad: an investment banker threw himself after learning he had no job
zw's now in three paras or less

The psychological disruption I touched upon in earlier pieces has now come to a screeching halt at noon. For the market to RALLY after such abysmal Chicago numbers (largest decrease of ~20pts on record; lowest lvl since 2001) shows that the pyschological disruption of October has come to an end. Last week on Friday I advocated buying JPYUSD @ 94.27 and we opened on Monday at 92.22; I'm extremely gratified by a 2% return on a fx hedge. I went bearish yen as I noticed the inevitable signs of a bull rally and then mid last-week I became convinced that market pyschology had turned; I'm now confident we're actually going to rally into year-end.

The end of the pyschological disruption is key remember the Chicago purchasing managers index is one of the most respected and tracked monthly numbers. It's a baroment of the manufacturing sector; the stalwarth of the Mid-west economic picture (heartland anyone?) and a leading indicator for consumer activity. A number of 38.7 means that more manufactures are reporting WORSE business than improved conditions. This was a very bad number and underlines the precariousness of the American consumer; the extent to which we are on the precipice of a vicious economic cycle. However equities rallied and they RALLIED hard, which means now that the equity market is back to the pattern of thinking; good economic data we rally, bad economic data we rally harder on further stimulus measures. This is a critical turning point and it picks up from what I said earlier in the month; "October is going to be a month of resolution and reconciliation". In October the market was working through the issues of systemic fears, banking collapse and interbanking funding; now the permabears are beginning to crack under the rush to yearend.

Don't get me wrong we're still going to see an economic slowdown of an unprecedented magnitude (though I'm still insisting on a V-shaped recession; the correction has been sharp and quick, which is VERY healthy) however the aggressive monetary policy taken last year by Bernanke is proving to be extremely prescient. Is it any coincidence that next week the BoE is now expected to cut 1% (double the mkt expectation of a ½%) and the ECB a half point. The rout that the (european) central bank governors faced on inflation is an indictment on them and the rates mkt who insist on "credibility". I wanted to write on bond basis but I think I'll leave it for another time.

At the theatre last night the playwright answered that she thought her play (which was BRILLIANT by the way; go watch it if you are in London) was a meditation on the dislocation between society, family and youth. I meditate on market dislocations and where we can hope to go from here; my three reasons for a rally: (1) the rallies of 1857,1907,1929 and 1987 all started on the 27/28 Oct. (2) PE ratios in US equities trend around 14; at the moment we're hovering around 8 and even assuming a calamitous drop of 50% in earnings (as opposed to the 25% growth projections, which is standard) still doesn't account for such low PE ratios. (3) Finally for month end reallocations many funds, to rebalance their books, will have to flow out of govvies into equities, which is going to give a boost.

I was looking through default rates historically and I'm shocked by 1 outlier during this cycle. Historically corporate defaults happen prior or at the very beginning of the recession; corporate defaults trended at 6% in the immediate aftermath of the Asian financial crisis in 97/98. I think we've been in a recession for the past 3months (at the very least since June 08 when the ISM dipped below 50- the most reliable recession indicator out there!) however non financial corporate defaults have remained very low (1.3% in 2007 2-3% in 2008 so far- bond mkt pricing in 10%, rating agencies expect 5%).

I think the stimulus package should not be underestimated; I think the real economy is going to weather this surprisingly well. A bear mkt recovery in 2nd Qtr 09 means that we'll have had a bear mkt for 2yrs which coupled with the 3yr bear mkt in the 02/03 cycle gives us one of the worst DECADES in equities post-ww2. The difference between Japan and the US is one of opacity and transparency; higher quality coroporates have never been wider than they are today (BBBs at 700 are -inflation adjusted- equivalent to 1931 levels). ZW

Late for a Tory drinks evening starring William Hague

I'm diving right in on the currency mkts! YTD a whole slew of ccys (basically G-7) have dropped around 15-30% against the USD whereas only the JPY has outperformed around 20%. I've just gone and traded some JPY; I think holding on to it over the weekend is a very good hedge to any overnight news emerging over the w/e. I like the Yen, I like the Dollar and I don't like any other ccy for now; agreed the technicals are soon going to turn (once Japanese are done with unwinding their PRDC or whatever funny sounding structure the whole nation was in). The fact of the matter is the panic trade at the moment is buy JPY, buy dollar next. The Japanese are waking up to the fact that they've been funding the rest of the world's economic derilium; why else would or should by long end TSY's underperform in what is arguably the worst equity crash we've seen in our careers (one of a series of drops in the last six months arguably)? If I had more time and didn't need to rush off to this event about Asian glitterati with Dad, Ray & Zain I'd actually a funny little graph correlating USDJPY, S&P futures & long end tsys.

If the Japanese have been fuelling our boom; it's the European and the Brits who have miscalculated. High inflation, as I was saying 6-9 months, did not exist. It was essentially high fuel prices (which were driven by despots, dictators and speculators; quite a heady mix there) and commodity prices (which are drived by fat French farmers, hungry Chinese migrants and greedy middle class Indians) AND Trichet began to spook the markets by somehow blaming us "the Consumer" by driving up prices (we didn't we swear!). If we know one thing from globalisation, modernisation and industrialisation is that a low-inflationary environment is virtually cast-iron guaranteed by the interdependent open economies and flexible wages (essentially subsistence wages). Inflation was a chimera and now EURO-GBP areas are waking up to that.

Quick thots on 3 interesting subjects. Hedge fund collapse is still a big issue; hedge fund names have widened considerably in the credit market. (2) We are entering almost the perfect conditions for a LARGE BULL RALLY this time next yr; I am very impressed that we are dealing with the crisis so efficiently. Finally (3) don't panic this is very healthy and THIS IS REQUIRED; this is in no way a systemic collapse. As some commentator here and there pointed out if this had happened two wks credit indices would have gone 200 wider on large volumes; volumes have been measured and the widening has been paced. There is no panic in the credit mkts and we're the biggest baddest bears out there.

KK out..
ZW's now in 3 paras or less
Dow down 300pts i feel we're going to rally into close with 1hr left. i'd buy the dow at 8392...

Systemic resolution month
flushing out the trash

Apologies for not sending out my daily ZW (I've dropped the idea of twice-
dailies in this environment- oversaturation) however after last night's petit
fete I'm much less worried about our impending economic doom. To paraphrase
Queen Marie "all you need is cake" especially one tied up in a little bow & in
three different shades of chocolate!

The trade to highlight is the gilt cash curve, which is 150bps steep (2-10s gilts have steepened 100bps in the last month). The cash curve has steepened dramatically and the best trade to put on right now is sell 2yr short end at 3.20 yields (good buy back lvl 3.50%) and buy the 10yr point of the curve. Cash flatteners particuarly in gbp space is the way forward as we begin to see short term gilt supply of a further £30bn gilts before year end.

In my winding trail of ZWs below I stated that October was systemic resolution month. I find it very odd that the markets should plunge on Mervyn King and Brown's acknowledgement that yes, we are facing recession. I distinctly remember a year ago that if there was the onset of the recession or bad economic data; the markets would rally like crazy on the prospect of further rate cuts. Are we really that inured against the stimulus of rate cuts that the FTSE dips to 4000 and the S&P is precariously close to it's 52wk low (only recently tested as recently as 2wks ago). What's happening to market psychology??

My thoughts are that the next ten days are when the "new world order" filters through to the markets. Yes we are in a recession; we have been in a recession and while we still don't know the outcome of a recession (I still happen to think it's a V-shape- short and quick and we bounce back painlessly & effortlessly but then again I am high on cake) it's going to stay with us for a while. Equity valuations cannot factor in 25-50% earning growth for the 09 year that's not just unrealistic but criminal; if anything we have to contend with an earnings DECLINE (shocker I know) for the nxt few quarters. Already European investment grade corporates are showing the way with TERRIBLE results (dsg, fiat, abb)..

The mantra above rings through my head.. To me it means accepting that in this environment one cannot anticipate daily market moves; a quick glance at the SPX index past 10 trading sessions confirms that.

However a trade that I really like in all of this tumult is long USDollar vs. EUR & GBP. I just see that while it's obvious to me that we are seeing the downturn rite now; the US is being swift & decisive enough to mitigate SOME of the possible effect. However in Britain after scanning this mornings headlines; "Darling to spend his way out of the crisis" Keynesian policies are the LAST thing that we need (breathe zak breathe). I am worried about this side of the Atlantic but very hopeful for our American brethren.

Interesting news events- the FED almost waking up to its role as a market stabiliser is now going to provide loans to money market funds. The other is the new Barclays € issue, which is expected to come to out MS + mid 20s (shouldn't it trade through MS? and over govts bmarks?). Thoughts on that is that the GBP swap spread curve; particularly in the short end is going to come under SEVERE pressure; can't be helped by another 50bn of "special" gilts soon to be issued by HRH to balance Brown/Darlings profligacy..

KK out...
ZW's now in 3 paras or less!

I know I am transgressing sacrosanct territory and committing a cardinal sin by saying that "it is different this time. Every investor tries to pin his policy errors on this one statement, long-shunned and abhorred but still relevant. I sprung into action when I saw my monetarist guru and close collaborate of Milton Friedman telling NYT that: "Firms that made wrong decisions should fail,"- Ms. Schwartz

As a monetarist student of Ms Schwartz, I most respectfully disagree and contend that letting banks fall is not the answer.

Ms. Schwartz who argued in favor of significance of monetary over fiscal policy to fight the great depression thinks that Secretary Paulson's shift from buying bank assets to recapitalizing them directly, as the Treasury did this week, has shifted the policy from trying to save the banking system to trying to save banks. In NYT article today, Ms. Schwartz now says "that's not what's going on in the market now."

In 'Monetary History of the United States, 1867-1960' Friedman and Ms. Schwartz collected enormous chronological data and pointed analytics to maintain that monetary policy--steady control of the money supply--matters intensely in the running of the nation's financial system, especially in navigating serious economic fluctuations.

NYT's Brian M. Carey writes in a critique today that 'Most people now living have never seen a credit crunch like the one we are currently enduring. Ms. Schwartz, 92 years old, is one of the exceptions. She's not only old enough to remember the period from 1929 to 1933, she may know more about monetary history and banking than anyone alive. She co-authored, with Milton Friedman, "A Monetary History of the United States" (1963). It's the definitive account of how misguided monetary policy turned the stock-market crash of 1929 into the Great Depression.' I'm a little surprised that Ms. Schwartz considers the treatment by Bernanke and Paulson as right for today's threat to the world economy, but considers the priorities of saving the system as misplaced. At least on one point everyone agrees that accommodative, stimulative policy is the right answer. The banks failed because of the contraction of last time and Fed's indifference towards the falling money supply. Bernanke did react immediately.

Friedman and Schwartz's analysis has by now become the typical elucidation for the Great Depression. In the very least, the book helped reinstate the significance of monetary over fiscal policy in the stabilization of the business cycle.

Austrian Business Cycle Theory had argued that the Great Depression was caused by extremely loose monetary policy that fed an untenable economic boom during the 1920s, which eventually collapsed into depression. Friedman and Schwartz argued that instead it was excessively tight monetary policy following the boom of the 1920s that turned a run-of-the-mill recession into a depression.

In their influential chapter 7, The Great Contraction--which Princeton published in 1965 as a separate paperback--they deal with the central economic event of the century, the Depression. According to Hugh Rockoff, writing in January 1965: "If Great Depressions could be prevented through timely actions by the monetary authority (or by a monetary rule), as Friedman and Schwartz had contended, then the case for market economies was measurably stronger."

Federal Reserve policy did contract the money supply by 1/3 during the early years of the depression. The Federal Reserve did revive the depression by increasing reserve requirements in 1937. The collapse of the banking system collapsed the real economy. The recovery of the banking system was important to the recovery of industry.

Keynesianism argued that the Great Depression had been caused by inadequate customer merchandise demand and lack of saver poise, and that government should compensate for this by increasing its spending and financing it with government debt. Friedman and Schwartz argued instead that the problem and solution were not so much a matter of fiscal policy as they were a matter of monetary policy. Government, particularly the monetary authorities, was the cause of the depression, not the solution. Active fiscal policy as prescribed by Keynes would in the long run not lead to an increase in economic growth and employment, but only to an increase in inflation.

In NYT article today ''Ms. Schwartz now says "that's not what's going on in the market now." Today, the banks have a problem on the asset side of their ledgers -- "all these exotic securities that the market does not know how to value."

"Why are they 'toxic'?" Ms. Schwartz asks. "They're toxic because you cannot sell them, you don't know what they're worth, your balance sheet is not credible and the whole market freezes up. We don't know whom to lend to because we don't know who is sound. So if you could get rid of them, that would be an improvement." The only way to "get rid of them" is to sell them, which is why Ms. Schwartz thought that Treasury Secretary Hank Paulson's original proposal to buy these assets from the banks was "a step in the right direction." The fear has made the entire global debt structure per se the bank assets toxic. This is my argument to Ms. Schwartz: Out of 4-5 trillion dollars of mortgage debt, part of which is structured and becomes the so-called "toxic asset" of the bank's balance sheet, is actually the entire mortgage amounts owed by families in the United States. So, I agree, it is trading at a huge discount, but on the other hand, the whole debt structure is sitting on the ability of the American families to service the debt. I have yet to see evidence of that kind of unemployment or that kind of a severe slowdown that would lead to total meltdown and the inability towards servicing this structure. The hybrid form of the structure that contains the subprime part has contaminated the entire structure and taken a big toll on the balance sheets of the bank, therefore, one needs to be careful about passing judgment on the assets of the bank. These are not paper assets, but those backed by mom-and-pop businesses and mortgages. If the case is so that most of the ABS, CMBS is toxic, then there is no repair, however, that does not seem to be the case.

One thing Ms. Schwartz may have missed in her article is also that in historical perspective this is the first time that the problem is stemming from top-bottom, not from bottom-top, that is, we are not seeing the kind of unemployment and the kind of economic slowdown as we saw on the onset of the Great Depression. And, one other dissimilarity is, the connectivity of the world which helps formation of situations like stagflation. Global economic connectivity eases out economic stresses like, definitely global slowdown has helped stem the onslaught of inflationary spiral of commodities and oil. Great Depression of the '30s aggravated as a result of geographical distances. Price stabilities were not exportable items, like Chinese today export price stability to the US and to the world at large. Labour markets are far more flexible.

Ms. Schwartz disagrees with Secretary Paulson's policy to shift from buying bank assets to re-capitalizing them directly, as the Treasury did this week. The revised bail-out package now has two components, one is the 250 billion that goes to re-capitalizing the banks and the second 500 billion for buying bank assets. But in doing so, he's shifted from trying to save the banking system to trying to save banks. These are not, Ms. Schwartz argues, the same thing. In fact, by keeping otherwise insolvent banks afloat, the Federal Reserve and the Treasury have actually prolonged the crisis. "They should not be re capitalizing firms that should be shut down."

Rather, "firms that made wrong decisions should fail," she says bluntly. "You shouldn't rescue them. And once that's established as a principle, I think the market recognizes that it makes sense. Everything works much better when wrong decisions are punished and good decisions make you rich.''

The trouble is, "that's not the way the world has been going in recent years."

I will disagree with Ms. Schwartz, letting banks fail is not the answer. The valuation of toxic part of the bank assets is an area where some more thought is required. The part of the debt that is toxic can be contained and may be that extreme negativity has resulted in far greater wiping off of the assets side of the banks balance sheet than it would be under normal market conditions. Fear has eroded lot of common sense.

The question asked is that it is well known that LEHMAN fall triggered the systematic risk at a far accelerated rate. Some say LEHMAN fall actually triggered the urgent response from the legislators who would have remained indifferent to a major bail out of the system. The cross third party risks are immense globally in a situation where circular debt can wipe clean even the strongest bank assets; letting major banks fall along with stimulative and accommodativeness monetary policy will lead to unmitigated disasters. Let the brunt of the hurt be borne by the shareholders but letting these institutions go down will deepen the crisis. These are uncharted waters and no road map of action can be predicted. However, it is nice to see that the 'monetarist gurus' policies that could have saved USA from Great Depression in 1930's are very much a part of the present policy objective of Bernanke and Paulson, instead of contraction the central banks globally are creating liquidity and money matters in the end.

The real enemy is fear and fear can only be conquered by restoration of confidence and firm policy direction, luckily both are being amply addressed this time around unlike 1930's. Even Prof Krugman advised Obama recently to forget deficits and forget inflation and go for growth. Diverse opinion in the conceited world of economists at last agree on action to stimulate and restore confidence in our ability to trust each other. Therein lies the cure of toxicity, it is more to do with minds than numbers, as I always say economy is little about numbers more about humans.

End of Week update.

I went to my local GP (not Doctor Fernando) last night for a check-up on last weeks fluttering heart. My doctor attributed my condition last week to surging levels of adrenaline. Apparently I have a case of "nerves" in that I'm hyperstimulated in my current environment (dur!) and my body (or heart in this instance) is sounding out the alarm. I've decided to up yoga bigtime, sleep (the best drug there ever will be!!) and general mindfulness -not to be so overly passionate about absolutely everything.

Where to start in my survey of the world economic landscape. I find it a very heartening example that new issues are beginning to flood the credit market now; today's GDF Suez (the new French utilities giant that was willed into existence by Sarko the Narko) 5 & 10, on negative basis of ~150bps, indicates that new issues are beginning to flood the market but at cheaper lvls. Also Diageo (the drinks & beverage conglomerate) issued overnight new debt $1bn 5yr issue that at L+325 shows that capital is going to cost alot more in this new and uncertain world!

As I said earlier in the week, and a few commentaries below, Oct is being spent on firefighting and systemic resolution. Credit indices are widening under pressure from systemic risk and the age old fear that we are going to witness a credit collapse; in that more banks are going to hoard cash rather than lend it out (isn't that a sensible thing?). I was reading that in Europe we can expect 4 whole quarters of recession, recovery in Europe is going to take much much longer than in the US. A sharp stake in the heart of the European Union?

I am adding a rule. All forthcoming ZW's will be limited to 3-5 paragraphs. I'm counting this para toward the limit as well :)

The system is being fixed; this morning Switzerland is bailing out UBS. Very simply UBS is putting it's 60bn usd junk assets in a fund; selling it to Switzerland for a dollar. UBS will take a special earnings charge but in return is FREEING up to $60bn usd of capital and allowing a 10% stake to be owned by the Swiss govt. The Europeans are managing this crisis extremely well in stark contrast to Bernanke/Paulson. Bernanke's testimony yesterday was meant to REASSURE the markets not SPOOK into dropping 700pts.

Before it turns into a mini-rant I want to focus on the current market fear; "deleveraging". The deleveraging cycle means essentially that with the near-collapse of banking institutions; there will be a fear to lend out to the wider economy, to Main Street. Even though overnight fundings cost have been coming down over the past three; quite dramatically in GBP (in no doubt due to PM Brown's vision) the fear is that these newly capitalized banks aren't going to lend out a weakening economy but rather sensibly hoard cash and maintain their institutional health. This turns into a vicious cycle whereby the expectation is that tomorrow will be poorer, worse-off and cheaper; hence why buy or invest now.

My thoughts very simply on this MORE govt. intervention if there are signs of a recession and fears that things are going to go south; then the optimal policy measure is to step into the commercial paper markets (as they have already done) and make sure that access to liquidity for corporates is guaranteed. If the market needs a correction then so be it but I find the argument that somehow our economic cycles of the past three, or in some case TEN, decades converge to this moment of market meltdown not only irrelevant but incredibly obtuse.
KK out for now.

Forget inflation people care about having a job!

While I was busy engaged in some task I was listening to Bbg tv, which drones on all day. In it a Columbia professor was asked whether because of the govt. bailout the US could expect to endure a 14yr downturn and his answer was "possibly but probably not". My observation is simply please take a stand.

Again I'm late for a Diwali party but I've realised that in a way unless there's time-pressure building on me the words don't flow as easy.. First off as per noon's write-up; CreditFlux (which is arguably the Credit Derivatives Reader's Digest) has it's headline "Force credit derivatives to clear through us, argue exchanges".

I don't like the idea of coercion but rather collaboration; setup a Bond exchange. Setup these exchanges I do not like the idea of market-makers, of shadow brokers, of counterparty risk and that Bloomberg screenshots provide CDS valuations. Let's standardise, let's homogenise the process so that in a way we erase the huge discrepancies that currently prevail. Setting up these exchanges, providing them with a regulatory mandate and basing them on the template of a Stock Exchange is a sure-fire way NOT to repeat the crisis again.

When looking at valuation measures such as the PE ratio and the House/income ratio it's very important to remember something else. These ratios and these values Grow over time; therefore PE ratios of say 10 for a utilities is going to grow itself. House/income ratios are going to grow over time; therefore house values may be 5time annual income but in a decade it could very be 7 or 8. That's because wealth is fundamentally, and this is a point I argued in the even of bust cycle last July, transcending it's original definitions. Wealth originally was your cow, then ur gold trinket representing that cow, then ur bank notes, then ur bank account and now we are reaching the level whereby Wealth is a proxy for pure human intelligence and creativity. Not to veer off point but that is the paradigm shift in equity and property valuations but as our needs expand so too our definitions of what it is to be wealthy. 2 centuries ago our poorest person today would have ranked comfortably in the high middle classes of most of the world; that shift is ongoing subtly but equally dramatically.

Well the best trade so far, the one stands out; is go long rates, put on steepeners. All world governments are going to put on coordinated rate cuts; perhaps not in so dramatic a fashion as before but it will happen. Today Norway cut rates by 50bps to 5.25%; overnight libor levels in gbp 5bps tighter. Not much is interesting in credit, with the new issuance firmly shut for now and a cyclical shift in anticipation of the recession. Again is question is WHEN and HOW will this recession act; I'm still of the opinion that it's going to be V shape bit of a dip but then a bounce back right up. When I look at interest rate curves I just cannot contemplate how with the amount of liquidity surging through the system AND repair of the systemic risks what is possibly going to drag down the economy.

3 very interesting news in the macro economic front, in US, Spain and UK. First retail sales in the US are down -0.6%, marking the first time in 17yrs that real consumption has shrunk in the United States. Without us knowing it consumed as we were with elections and banking meltdown the US is going through it's cyclical recession, a process it started all the way back in may (well feb-july/aug) 2007. The US on a macroeconomic perspective is suffering but the remedy of 1.75% (and on average 2.5% rates climbing down from 5.25% in july; which had been the level for a whole yr) has been in place FOR OVER a YR NOW (apologies for the emphasis I'm trying to limit them as much as I can but sometimes can't resist).

In Spain we have had another series of house declines of 1.3% in Q3; making it probably that Spanish real estate will drop by over a third next year; Trichet you may regret the last four months when you focused on inflation so intently. And finally in good old Britain we have the spectre of mass unemployment (3mn or 9% of the population in 09); PM Gordon watch this space. Forget inflation people care about having a job!

I really must go there is so much to say but HUZZAH (okay stopping with the emphasis I think I'm an addict to Caps locks) to oil finally dipping below $75/ barrel; remember $300 oil? This is the first time oil's been at this level since August 07; the perennial bull always likes to leave his readers with the bright side of life!

KK out.

As promised I hesitantly begin to write my twice daily piece; what was supposed to be a morning shoot-off turned into an afternoon one but even so.

The best place to start is the optimistic earnings seasons in which surprisingly BOTH JP Morgan and Wells-Fargo beat expectations. JP Morgan still managed to turn a profit in what is arguably the most horrific post-war banking crisis. However 2 NEW FACTORS will result from this crisis:

(1.) The validation and acknowledge of the sunspot theory, which not to be labour but that market paranoia tends to feed itself until fiction becomes fact and we're all held in MASS psychosis. I think anybody who is the least bit familiar with mob psychology would realize this to be true. I'm a BIG believer in Vox Populi Vox Dei, voice of the people is the voice of God, but I also recognize the need for an impartial arbiter, which happens to be the Govt. Govts are the natural regulators over market excesses and arbiters of fair value; no speculator can take on the G8 since they take on the bastions of our entire global economy.

(2.) We are seeing the evolution of High Finance, particularly the ignored sister of Equities; Fixed Income. Why did this CRISIS happen in the first place because we DON'T have a BOND EXCHANGE. The fixed income market is opaque and high risk because the infrastructure is developing. If we had the correct systems like the Stock Exchange none of this would have happened. Does anybody grasp the significance of this; if the Over-The-Counter Market (which is where all the money was made of the past decade) had a central clearing house and if there had been a Depository Insurance Scheme system, which was systematic and comprehensive THERE WOULD HAVE BEEN NO CRISIS! The crisis is because WE IN FIXED INCOME did not implement the proper Procedures and systems when times were good. Our measures have always been reactive rather than Proactive.

What I find interesting is that all those folk who seem to think this is the end of Capitalism, the start of regulation and the beginning of the End for bankers are skipping over an important fact. Capitalism needs, nay THRIVES, on regulation; the right sort. Russia is more "capitalistic" than the US but no sane investor would put their money at same return in the RGBI debt than in US treasuries. Is it not remarkable that through this that over TIME US long bond yield has REDUCED. This means very simply that the trust and goodwill has increased in the US Govt. As an unabashed Young Republican (God that sounds like a dirty word now outside of Middle America!); let's track how the Long Bond has done on both of Bush's two inaugurations.

January 20, 2001 5.553% (19th Jan Friday lvl)
January 20, 2005 4.644% (21st Jan Friday lvl)
October 14, 2008 4.24%

So under the reign of the "worst" President in history (same drop in yield from ~9% to 5.5% effect for Prez Clinton btw); the US has REDUCED the rate at which it borrows it long term obligations by a 131bps. Now I don't know about you but that's pretty remarkable for a defunct administration. The reason I highlight, and yes I sound demagogic & partisan, is to underscore that the Goodwill is not the opinion polls of France, Germany & Pakistan (whose own leaders don't listen to their people) but rather where people are keeping their money. And that ladies & Gentlemen is in the US of A; in fact the world is funding the Iraq War & other "bankrupt" policies of the administration.

I don't want to go into a political rant but it's indicative that a lack of grasp in the political ordinarily translates into cognitive dissonance in the market place. Please don't listen to the liberal media who are trying to will us in to a Great Depression. Remember if we're to know one thing about Quantam Physics it's that the act of observation in itself affects the experiment.

KK out for now; catch u later.

I think there must be a part of me that's hard-wired to write ZWs at the very last minute. Why must it be that I have exactly 5 minutes to finish my piece before I've even started.

two corrections; when discussing libor i meant it as part of loan agreements libor is reset every three or six months. libor is reset daily; my point was that very high libor rates (which are coming down gbp libor -17bps today) will not have a cascade effect on the credit contraction. thank you for the feedback

also a source corrected on the obama intel; he was introducing the idea of withdrawal UPTO 10k usd on from retirement accounts at the moment you are allowed none. I like this idea and my respect for OBAMA/BROWN increases. I hope Mccain is really up for the challenge he seems to be holding back..

What are my preliminary thoughts as I've scanned the macro-economic environment. Inflation at 5.2% in britain and the eurozone now seems to be feeling the effect of a knock-on recession; zew sentiment numbers were much weaker than expected. the fiscal MAY have come into late for europe to avoid a delibilitating recession.

I think what remains a very important issue at the moment is the intersection between rates and credit; namely the transferability of uk and euro bank debt into govvie debt. I think the equivalent situation with the banks is that AT THE MOMENT they are the pre-bailout FANNIEs & FREDDIEs; they are current GSE's. Government sponsored enterprises; therefore while they have the IMPLICIT backing of the government they don't have the explicit and from what I understand of the Guarantee structure the govt backing is the First Lien debt; the govt. in the event of bank failure can and will possess the assets, a mandatory liquidation and seizure of the banks.

I would have been very worried had money market rates and uk/eu equities now rallied behind; it would have shown a dearth of confidence in the institutions underpinning these governments. For the first time as PM and otherwise in quite a while PM Brown has displayed a high risk strategy; that has spectacularly paid off. The Tories will find it very hard to win the next election against this new, aggressive and energised Brown. No wonder shadow chancellor Osborne was railing against Brown's measures today; like it or not PM Brown displayed leadership in a morally vacuous political environment.

The world is going to take the rest of October to firefight against perceived systemic risks and that's a good thing. As we head into a collective respite for end of year I think the key question is going to be those sectors that are able to continue the rally in an uncertain economic environment. Remember 1880's sunspot theory; the theory that if the market believes it to be true it will become true. In a way if the market and consumers somehow believe times are going to be tuff they are going to be tuff! Pop quiz what's the outstanding debt of US & EU & UK governmental organisations; it's a good figure to contextualise..

KK signing out

the title reminds me of an easy trade that I had been advocating but did not put on..

I've been exceptional late in churning out today's ZW. My plan is to graduate the piece to a twice-daily; get in early morning (at 7am) and quickly shoot off some thoughts of the day. This is as of yet an unrealised ambition and should my mother get wind of it I dread to think at what ungodly hour she'll push me (5.45am wake-ups are torturous enuff for me!!) out of the house so I can be to "work on time". So as of yet it's hush-hush but I will make an effort to send ZWs earlier..

I titled today's piece the soaring abyss because I'm just so bemused by the schizophrenic market that we have. The DOW just closed and has one of the greatest rallies (+1000pts); which makes it the 5th largest percentage gain on record and the largest absolute gain on record.

My initial thoughts are and I can't believe I am saying this; CONGRATULATIONS PRIME MINISTER BROWN! You have saved the World Economy and I have to hand it to you that Britain under your leadership is directly responsible for the astounding about-face that we are seeing right now. Do I find it ironic that New Labour is nationalising the banks; in a way this is a confirmation of my Tory nightmare; a socialised Britain.

But Brown and Darling, to their credit (and my vote is back to swing because I am VERY VERY impressed) grasped the need to SAVE Capitalism from it self through nationalisation. It's very easy to equivocate crises and somehow draw meaningless patterns; as some SMARTS (contraction for a favourite insult for mine; I'll leave the intelligent reader to guess at it) are now drawing fanciful comparisons betwee 02/03, 87/ 73, 32, post war, pre war, 1880s etc etc you get the drift. The point is as Tolstoy remarked "happy families are all alike; every unhappy family is unhappy in its own way." In the same way while booms may involve the same psychology of paranoia, blind optimism, unmitigated greed and yes fear of underperformance; Busts are an entirely different animal.

Are we headed for an economic recession; well I'm glad to see that so many commentators have flip-flopped and now modified from outright Global depression to Brad Delong's money quote "worst recession in 25yrs". I'll take that and modify it to a contextual exercise on the American & European mindsets.

The american resposne has been fiscal and monetary, reflecting the state and strength of the union, at 1.5% o/n rate the borrowing stimulus to the economy has already been felt. Does it matter that most lending is done at LIBOR and that libor for the trio currencies remains ridiculously high at 4.5%/5% (it's been coming down); anyway it doesn't because LIBOR is reset every 3 or 6months. Therefore from an economic perspective we won't feel the effect on a credit contraction cycle from abnormally high LIBOR rates.

Anyway to make my point before I shoot off home (tonight was meant to be the gym but that won't be possible instead it'll be a yummy curry at home and bantering with either/both brothers) Europe responded to the crisis from an infrastructural, systemic and intellectual basis. Hence the preliminary moves by Trichet and Brown have been exemplary; guaranteeing liquidity all the way back in September last year and preventing European institutions from failing. This reflects the intellectual institution and consensual bias of the European union and ethos.

The US with it's notorious distaste for expanded govt. (Obama has just released a policy measure that's chilled my heart; penalising withdrawals of more than 10k usd from retirement accounts; EU please elect Obama instead of Blair as the President of the EU) failed to respond to the crisis from an systemic view point instead it has tackled the Macro economic slowdown and preempted that.

Therefore my trading ideas would be that now that we have gotten the systemic bit (hopefully) look to add risk in sectors with exposure to US vis. a vis Europe. That's going to be the bonus RV trade of 09. Corporates and financials with exposure to the EU economy are going to weaken in comparison to those with exposure to the US economy. Rates in the Eurozone are going to dip quicker and faster than they are in the US. Finally I see only the USD strengthening vs EUR & GBP. My timescale is this time next year 09; when we're in the throes of another recovery.

I leave good reader with a simple question; now that the stimulus tap is turned FULL ON how are they actually to reduce or turn it off without causing everything to crash. Yes we are going to jump from this crisis into bubble cycle; this though GOVTs around the world please be more of a HEDGE FUND.

KK out
remember Q4'05

Revisiting "Asia rides high - for the moment"

Pan Wei, director of the Center for Chinese and Global Affairs at Beijing university, mused aloud to me that: "My belief is that in 20 years we will look the Americans straight in the eye – as equals. But maybe it will come sooner than that. Their system is in chaos and they need our money to rescue them."

Look what 40 days can do to the global integrated economy. No one is riding high at the moment.

Without US and western consumption pattern Chinese's economy will stall. In last eight years of spectacular boom Chinese produced for all of the rising middle classes, now with Spain straddled with 100 of thousands of unsold houses and USA stuck with over built Chinese economy will need to invest in their own infrastructure and try to eradicate their own poverty.

If Chinese are smart they should invest inward in mass projects to uplift hundred of millions in rural China, who live just above poverty, their 1.3 trillion US$'s intelligently used can bring Chinese to look Americans into eyes as equals but probably they will spend all that to buy the recently passed bail out bonds. No market in the world is big enough to consume Chinese or Russian or Arabs sovereign, one way or the other they find their way to the US treasury. Irony is that export driven Chinese economy need a great spending lust client and to keep the customer afloat they need to support the IOU paper that customer uses (USA) to live on.

This whole sell off is joke, how can one sell stocks and market of a nation and bid their paper stronger, it only reflects that selling is without any reason, this very stock market provides the strength to the paper that US issues as IOU's and treasury, if stock market collapse so will be the ability of US to honour its AAA obligations.

On one hand Investors are selling US stock markets however on the other bidding their treasury up, the yields on treasury are falling under the caption of flight to security, but isn't it strange that Treasuries which are nothing but IOU should be selling too if the underlying economy is being weakened with indiscriminate selling of the stock market, this delivering should normally result in selling of TB's too, but strangely enough the bail out will cost the USA little as sovereign funds are ready to purchase the new bonds steeper and at far lower yields only Americans can do that.

WE are prisoners of market efficiencies, we have irrational exuberance and irrational apathy, this irrational apathy of the markets will move the capital stuck up in the coffers of BRICs to the best use i.e. consumption.

The global economy fundamentals are not zero sum games, if nation have to progress they need to help each other out, the new global paradigm makes sure that whatever money was pulled in Arab sovereign funds, Chinese treasury deposits and Indians and Russians new extraordinary forex deposits should find their way back to where it originated.

Oil was at 147$ as pundits said that peak oil is correct now oil is at 78$ and pundits feel that global demand is falling like a stone, last three years of over production by Chinese put a lot of pressure on global commodities now next few years will be inventory utilisation and slower global growth years, the commodities boom is over for now, the prophecy of recycling of global wealth is a very fulfilling truth, we are seeing platform of a new bull run form the ashes of this doom.

http://blogs.ft.com/rachmanblog/2008/09/asia-rides-high-for-the-moment/#comment-14539
Posted by: Iqbal Latif | October 11th, 2008 at 7:12 pm | Report this comment

Whatever happened to the mono lines?

I've been trying to understand my own personal journey this week as I witness the perpetual onslaught, nay the suicide, of a distinct era and a way of life. I would equivocate this to be the end of the Roman Empire; the same psychological dissonance and even more so the implicit understanding that we are witnessing in some form of "history in the making".

What to say, where to start?? First off I want to commend the Icelandic Central bank, Sedlabanki for explaining itself so cogently and coherently. http://www.sedlabanki.is/?PageID=287&NewsID=1890. It's a wonderful precis of how the Icelandic Central bank has been trying to engage in currency swap agreements with other stronger Central Banks since March of this year.

My thoughts on Iceland are that there is something suspicious about this disproportionate and overweight excessive banking sector. Also why the sudden cold war between Iceland and UK; there is something very fishy going on in Iceland and it's not their newfound interest in fishing. I think Iceland is the bland Scandi Russian (i actually wrote soviet; Freudian slip if there was any) satellite jutting into the heart of the Euro-American Atlantic sphere. This explains the vicious enmity towards Iceland and even the almost callous behavior displayed toward it by the Western powers. Why would Russia lend Iceland 5bn usd; Iceland is the new Finland.?. There is something very very wrong here!!

What else to touch on; GMAC (merge it with Chrysler & Ford) and MS. MS needs a RESOLUTION as soon as possible and I think it's a good company. Now either the FED will do a capital guarantee solution or otherwise we are going to see a default over the w/e. Remember we are in a GAME THEORY simulation of PRISONERS DILEMMA; we're all fu..ked but we don't to be fuc..ed the most. So what we're doing (and Mitsubishi and the other powers to be) are just biding their time like vultures; when there are no bids and it's buyers market what you gonna do Hot Shot?

Now this is where the govt. has to come in; either do the same mistake with Bear, Iceland, Pakistan, Lehman, AIG, Freddie, Fannie, and every other financial mishap that's happpened since July' 07. Does anybody remember when HSBC had to write down Household for it's subprime exposure in 06 and issue the FIRST profit warning in it's history. At the time it was such a scandal but now thinking back HSBC by confronting the problem so early manage to avoid the excessing of the following couple of years.

PAULSON PROVIDE THE MINIMUM BID FOR DISTRESSED BUT VIABLE COMPANIES!!!!!!!!!!! (I'm way too passionate about all this I need to get a life and soon!)

I bring up HSBC because we've had >500bn US$ write downs since then and we've been able to survive it; because we are an ADAPTABLE liberal democratic system. And we will survive but we need strong leadership, three things in our favor:

(a) Govt. should provide capital guarantee (where the hell is the fair value bid for MS; is it really at 9usd). Please bring confidence back bush-Paulson-Bernanke to the stock market.

(b) G20, please do guarantee interbank flows and failure; let's not have another Iceland on our hands. Perhaps it could be that DOW falling 700pts is related to the endemic lack of trust in counterparties that we've never seen (I was laughed off when I asked about cpty risk as a young bright-eyed graduate all those years ago)? Please guarantee and save the system?

(c) Close the stock market for a few days, give us a holiday. Let's discover what really matters in life. I've had a fluttering heart and I'm 23 years old; also at dance class last night(yes i did make it in the end and I ran around the park- so happy!!) I thought I noticed a wrinkle from the classes. I'm feeling weary and I don't want to look old. Imagine that's me relatively fit (I use that in the loosest possible manner); think about the veteran trader who's unhealthy and who's entire livelihood is based on the market!! It's not good and it's not fair; give the market a break while we sort out some measures. And remember when 2yr USTs are 1.61% (which incidentally has been the lower since the 02/03) recession it means the world and the markets believe in the FED. YOU HAVE YOUR CREDIBILITY BEN USE IT WISELY!!

KEEP INTEREST RATES LOW.. GUARANTEE A FEW BANKS; DON'T WORRY ABOUT YOUR CURRENCY AND SAVE THE SYSTEM. I had no clue why the DOW was up in the first 10 minutes the Fundamentals without US govt. ----> DOWN DOWN DOWN.

Enough of me I'm going to shut up now; have an AMAZING WEEKEND and I'm going to focus on my own spiritual recovery in the interim. I realized I was allowing myself to be defined by my mortality; instead as I wrote on Latif's Cavern in May (seems like AGES ago).. "While others are conscious of their mortality be confident of your immortality. Henceforth every moment will seem like an eternity." I plan to do just that...

KK out.

I'm running hideously late for an event where I get to hear a Tory MP speak (and I spent 7 quid). I also invited 6 guests and I'm contactable by phone. But such is my dedication to spout that I'll leave y'all with a brief runthrough on my thoughts on two key actions; British intervention in it's banking sector and coordinated rate cut (anticipating the BoE's official decision by a whole full day).

Finally the CB's are beginning to realise their role as agents of active government intervention in a system that has clearly failed. When sentiment is as negative as it has and continues to be so; I think some introspection is required. Make no mistake today was the equivalent of the CB's bringing out the artillery; I can remember a year ago (well August' 07) when a move like this would have triggered a post orgasmic bliss for a good 5 trading sessions.

The CB's are overreacting; thinking of the global economy as one coordinated organism (which is simple for me; as one trader wrote today "he'd never seen such unity"; his post dripping with sarcasm); the world economy just had >50% of it's economic weight receive the stimulative effect of such a massive rate cut.

This is invariably going to stimulate the economy, lag effect 18months. My call that we will be bullish in autumn 09 and that the FTSE is going to top 7000 in summer 10 doesn't seem so outlandish after all.

My thoughts on Brit govt action is that the guarantee has been more effective than the capital injection. This is what the govts. should have realised a LONG TIME AGO!!!!! Why are banks TBTF; two reasons which have nothing to do with Moral Hazard. (1) They hold deposit accounts, every depositor must have full and absolute trust in his banking institution and (2) for the increasingly large OTC market (which is responsible for the leverage which is responsible for the increased prosperity of the last decade) Banks have been CPs to one another.

The govt merely have to guarantee these two functions and allow the equity & debt wipe out to begin. It was an interesting observation that in this 1trillion wipeout (japan suffered 250bn usd wipeout when 10% in the last few sessions) the brunt of the burden has been localised NOT on the principals but on the Intermediaries; on the banks of itself. Imagine the revolutionary nature of this cyclical burst in that it is the top who are suffering disproportionately; if that's not Karma I don't know what that is.

Okay I would love to write a lot more but (a). I write much too much and (b). I really must go. KK out

Zack corner..America the Hedge Fund Nation

"Ending the bubble-bust phenomenon- another macro piece in a bludgeoned world"

I've been prevaricating on writing my thoughts because in this time of such great uncertainty, it's foolish to somehow try and analyse the course of events. The time for conviction has never been greater and after listening to Ben & Bush on the tv I think I have a few thoughts I'd want to sketch out here.

This correction will have thought one thing; that there is a way to end the boom-bust cycle. How can it do that with the government taking on the role of not only regulator but ultimately (and I hesitate to write) ARBITRATOR of fair value.

Greenspan essentially admitted that there was an asset inflation bubble. The Feds (in this case I mean the govt. and not the actually institution) should begin by investing in the economy.

Am I arguing for nationalisation; does an atheist argue for the Pope? What instead I'm trying to highlight is that in times of known bubbles and busts Govts should provide a fair value assessment.

Okay how do we do this; well it's fairly a trivial matter and it's simplicity astounds me at times. What is value; it's expected future cash flows discounted by both the discount rate (rate of return) and the default rate.

The discount rate is fairly stable (essentially the risk free rate of return; the alternative return for the asset) however the default rate is what fluctuates and what's being priced in by the markets CONTINUOUSLY. Both equity and credit and any other risk bearing market is pricing it's relative value assesment on the likelihood of default, of meeting it's payments and honoring it's cash flow.

What the government has to do is that when it sees massive distortions of risk; that is default rates are wildly inconsisent it has to begin "intervening". But not in the traditional mould of a governmental institution in which regulations suffices but rather as an active market player. It begins to "arb" the market and buy the asset, when it is dramatically undervalued, and sell assets (the idea of governments shorting is a bit drastic even for me) when the market is pricing in too low a risk of default.

How do you derive the risk of default I'd propose the methodology to be created by Moody's or a collation of independent arbiters who are able to standardise and methodise default rates over time.

Instead of the US being a Hedge Fund Nation; it would be an asset manager holding assets in the people's trust. It would be like any other shareholder except that it would never go bust.

This is in line with a fundamental free market principle; capitalism is driven by a mixture of fear and greed AND cognitive bias (essentially irrationality). That means that in times of bubbles and bursts irrationality grips and the market just capitulates (erm take a look at DOW & S&P equity indices; down >25% on an annualised basis but in EUR, JPY they are already at the year's lows) and seizes up.

What capitalism requires is the last RATIONAL investor, who is both significant enough (sorry Warren your an Amazing investor but I don't 5bn usd is enough (at the moment ur just breaking even on ur investment in GS even though at one point you were up more than 20%) and detached enough to act purely in terms of a long-term consideration.

Pure capitalism is Boom, boom, boom, PATOOZ- a long and long winded. Such creative destruction is a beautiful ideal but in such an increasingly synchronised and "inefficient" world it's impractical to keep.

Keep the government as a long term asset manager and next time round we may just have sweet dreams. KK signing out..

Tribute to Gov. Palin's remarkable remark last night "democracy is only a generation away from extinction".
Market maven Zach makes his morning call, I am one of his keen follower and have encouraged him to take his neck out and be bold, this his note today....

I modify that for this piece that these markets are economic mini-cycle away from systemic collapse!! We're holding our collective breath for a bail-out package, which may or may not prove to be a panacea. My question is that if it's passed tonight and tonight the inevitable (hopefully) relief session comes through what happens next week when we wake up to the fact that the bailout package is going to take time to actually be setup and implemented.

What do we and the banks do in the interim; twiddle our thumbs, take a sabbatical, cry wolf and send equity indices down a 1000pts and over to 700? In banking & finance, in trading, in London (the imperial aegis of our liberal capitalistic democratic order) we look at the world in three month-cycles; last June was ages ago and next Jan seems too far away to matter.

I bring this up to remind us that Dec/Jan 9mnth USD libor was where it is now and the TED spread (which tracks the diff between libor & t-bills) is 26bps+ @ 3.60% (record high); but in the interim we managed to climb out of the abyss just fine. Just now flashing through the Bloomberg schemes we see another iteration of yet another liquidity measure by the BoE (C.Bs where were you a year and a half ago; why didn't you anticipate this; unfair to ask i know no-one did but you're the economic gurus meant to steer this new global economy to soaring heights and tight pockets; Professor Bernanke indeed).

I don't want to be a data-cruncher; at this point in time it's not something I'm comfortable with since I think that at least for the next few sessions you have to be guided by instinct and knack. At this moment in time we have to understand the market has COLLAPSED; sentiment is no longer there (astutely pointed out to me this mng that rates market was pointing out 100rates cut for GBP and FTSE was down this morning!!).

We are actually looking to our leaders to rescue us and therefore this is one of the very few moments in economic history ('28, '72, '97, '02) when high finance and high politics actually coincide. My daily horoscope I think pertinent for the canny investor; "don't soak yourself in other people's worries; hide yourself away from the hustle." I plan to do just that; I hope you do the same during this period of market mayhem.

Stay long Eur rates, put steepeners in Europe and sterling space; look at rv opportunities between Eur & GBP I think we need to see Euro at 3% and gbp at 4%; a pt or so lower than they are now. Stay long the USD vs GBP & EUR but look at selling USD/JPY; it was sub-100 in March and I think it could go there again. 'nuff said; great weekend. KK over & out..

Go take a hike short-sellers! Go build something before you sell it.

As a family totally embroiled in the saga of US financial institutions, I have a bird's eye view of the 18th September events with personal exposures open to Credit Suisse, Merrill Lynch and other banks, and three sons work for three prime institutions. For the last five years, as promising young bankers, they've done very well. They are on the front line and work on the sections where they trade and try to mitigate the effects of the subprime products. On 18 September, all three were in constant touch with me on what was happening on the trading floors. It was the day that will be remembered when short-sellers had gained the upper hand. By 12 noon to 2 pm when I was on a flight to Paris, short sellers had crippled one of the institutions completely. The share was trading at a level whereby it would not be liquid by the end of the day had it closed at that level. The short sellers had targeted 35 banks.

The problem with hedge funds is that any weakness in the system can be fully exploited with a naked short, as you can short much more than outstanding shares. Nothing stops you. 18th September is one of the benchmarks in my career. As I landed in Paris, I had 15 missed calls; there was total mayhem on the floors of the institutions. But exemplary will of the MS chairman like John Mack helped the day. A Hedge Fund chief visited him earlier in the morning and told him that he wanted to take the money off, that the counter parties were not trading with the bank, not taking third party risks. A bank that has come out with stellar earnings was being treated as a pariah. Anyone who understates successful people at these financial institutions does so at his own peril. These are alpha males – highly motivated, proud, arrogant and they are the movers and shakers of the global markets. The subprime mess was not created by them, but an effort to make credit available to people at the lowest strata of society so that they have the pride of owning homes. But that is what capitalism ensures and is all about. It claims that the invisible hand of greed helps all boats rise. It went wrong. And the short sellers were like aliens in the highly fictional movie, Independence Day, where the world's only hope lied with a determined band of survivors uniting for one last strike against the invaders before it's the end of mankind.

Yesterday, the demise of any of these financial institutions by the short sellers would have done irreparable damage to the global markets. The announcement was made late in the day by Henry Paulson and Ben Bernanke that they are finalizing a plan for the Congress to form a Resolution Trust that will take away all the toxic debt of housing and credit markets, which is the basis of the shock waves through Wall Street and around the globe. The political will was shown by Nancy Pelosi, the House Speaker, who said "we hope to move very quickly; time is of the essence." That staved off Judgment Day. This collective action was a requirement of the day; instead of picking up individual institutions, the efforts of the short sellers to bring the entire financial set up of the world to naught, were stopped in rails. The grand scheme to bring down 35 banks would not have stopped after Lehman or Merrill or Morgan Stanley; they would have then come together again and attacked the newly merged entities of say, Merrill and Bank of America. The whole purpose was to invade and destroy. And the best weapon shown by the institutions was their will to survive.

Morgan Stanley and Goldman Sachs are no ordinary people. The panic hit between 12 noon to 2, when even the supply of Morgan Stanley shares started coming from insiders. That was a time when John Mack's determination and the resolve of these institutions that they will not allow themselves to be Lehman came true. As I said, these are extraordinary people who take pride over what they have achieved in life and they stood up to the vultures. Some employees may have sold but there was a clear message: We are not going down.

18th of September was a day which could have become the 9/11 of the financial markets. This was the ultimate encounter where mysterious and powerful hedge funds launched an all-out effort to knock out the institutions based on which our prosperity depends. The biggest conventional wisdom in the common man is that if you knock out the rich people, the poor will prosper automatically. But what they don't realize is that when the invisible hand of greed knocks out the rich and self-motivated people then the hardest hit are the poor. They are the ones who suffer most from the depression like in the 1930 Great Depression, where the unemployment rate was as high as 30-35%. Taking out banking institutions of the world would have collapsed the entire global markets. The new rising middle class in the developing world would have been the worst hit.

Now, the inside story is that yesterday was not one without sacrifices. Most of the so-called prosperity that our family has achieved lay in ruins because my sons had lost all the valuations of the bonus shares they had received in the last 5 years. But the instructions from me were very clear: "Go down. Loyalty is all that matters. If that is what it is, let it be." I have yet to find a single constructive short-seller. Short selling is selling something you don't own. Yes, it is not illegal but to make it an instrument of destruction where even a company like GE could have been brought down is unacceptable – it was down 20%, with phenomenal earnings! A day earlier, Morgan Stanley had announced the results and that they had $180 billion dollars of liquidity, but the issue was not about how firm or good the balance sheet was. It was all about the game of death orchestrated by leading hedge fund managers.

I think most probably there will be a temporary emergency ban on all short-selling and this ban will apply to all stocks of financial companies, even to all public companies. Although the markets are not yet out of the woods, it looks like right steps have been taken. This is the first time that Congress is going to initiate a plan that is being put together to help the entire banking industry as a whole, instead of selectively bailing out a few institutions. It's show time for the short sellers. They have to cover and cover very soon. Rumour-mongering and bad news will not work. Own your stock before you sell it. Build something before you sell it. Don't sell something you neither owned nor built. Mediocrates in life always have an axe to grind against alpha male people; there is a sense of relief and glee in the hearts of hundreds of millions with the positive action to protect the banking industry.

China Investment Corp is about to buy 49% stock of Morgan Stanley. CIC has $200 billion from the Chinese government to invest. CIC President is meeting Morgan Stanley on the weekend. SEC has made temporary short sale ban on 799 financial institutions in concert with UK Financial Service Authority. This is to protect the quality and integrity of the security markets and strengthen investor confidence. Go take a hike short-sellers! Go build something before you sell it.

Over the last ten years the S&P 500 has returned a meager 2.88%. Why? Because in the long run the market doesn't like bubbles. We're now in the third wave of bubble euphoria and we're hearing the same underlying message that we heard during the first two, just in different terms. During the dot-com era we watched tech fly to P/E multiples of 200 and above. When fund mangers were questioned about investing in such companies back in 1999, they collectively responded by saying times had changed. Lofty valuations became the new norm-until they crashed that is. The Nasdaq (QQQQ) still isn't even half of what it was in 2000. The market's punishment of the dot-com bubble has lasted for seven years.

Today at 12:26am

So I came across this last night on an old email circulation to and from our Sunday Football list… started off by an article in response to someone who complained about having to work on a Sunday... here's the full copy and paste:

(Note, I tried hiding identities, just in case)....

Guy # 1:
"Bankers Use Secret Clinics, Nurses to Beat Breakdowns" 1*

Another Guy # 2:

Dude I hate these little banking sob stories... Bankers have never had it so good... Even when they get laid off, pikey 19year olds get as much as most ppl get in a year as part of a redundancy packages.. Greedy over fed and low pain threshold.. Crying in the office, my god, most likely because they cant find their prada bag on line.... I counted that I ate 8 little animals yesterday as part of a five course meal in a restaurant yesterday, recession what recession......

Another Guy # 3:

??? - You forgot to mention that 5 of those 8 little animals were interns looking to break it into your high-powered, carnivorous World. You should be the new Wolf of Wall Street.

I admit that the nature of living standards has shifted so notably over time that a recession now is not typical of a recession previously. We're not back in Ted Heath's 3-day working week, that;s for sure. However, you cannot deny there is a slowdown – albeit measurable in nature and probably finite in length - markets are down 20% from an over-inflated and somewhat unjustifiable peak (pumped by you fixed income financiers in the first place). I guess it's a little hard looking at the impoverished from three stories in Lancaster Gate, or at least in the taxi between your trading desk and abode!

As for the low pain threshold, I do agree on this point however. People are having to shift from a triple cream, venti frap to a straight up, tall white americano - tough life - they may even take the leather off the seats first.

Consider your vantage point . It's like when I play you in football; from my vantage point- you'll never win that tackle!

Guy # 2 Response:

I was going to let this pass until that terrible insinuation: "pumped by you fixed income financiers"... My god, you pikey equity trading, hash brown eating afrikaner, who should have been left growing potatoes in bulawayo than be allowed anywhere near a trading floor...

Where was the blame, when we created the value, the liquidity, the stucture for the world to grow infinite number of times in the last 10 years... The reason we are not stuck in a pisspot 1950s style recession is because of us... We exponentially grew the world's pie 10 times, and now you cant take the pain of a slight technical reduction which was bound to happen?

I will put this to you right now, this is nothing more than a technical reduction brought about by the late reactions of equity traders, who were too busy to notice the subprime crisis pass by their very noses in 07 and are now trying to short the sh*t out of every single financial out there (look at all these hedge funds being allowed leverage to take Lehmans to the cleaners by shorting them)...

There is no recession, there is no need for a 3 day week, simply because this whole thing has been over exasperated.. This is all that happened, we over structred hard up peoples mortgages which was a bit ambitious, so subprime was created, subprime is 5% of the US total mortgage market (around 3 trillion dollars), that's now worth 0... Fair enough, its painful but that's it, its just 5% of the market...

The domino effect has been the problem, instead of ppl being mature and saying ok, xxx billion will be written off, they took it the wrong way... They started getting scared of leverage, for the first time ever honest to good, salt of the earth equity boys, who spend 7 to 7 in the office, read the Sun, and can just about follow a chart, got scared and realised as they blinked for the first time in this new financial dawn (1950s style investment banking starchy suits in particular) , that my god everything was leverage, the banks run with it pumped in their veins... And gradually, they took that away, it became the bad word, and once they did that, everything else crumbled... Without understanding it, they condemned northern rock, they screamed look they have some SPV with exotic products, without understanding they condemned.. And institutions got damned with the condemnation of the ignorant masses... No leverage in the systme, no blood in the veins,

Northern rock collapsed, bear stearns sold at $2 less than the value of their building, simply because a bunch of equity boys and investment bankers got scared of the word leverage...

And now the icing of the cake, Lehmans will go the same way, a great firm with smart people will probably end up with a bunch of arabs for 2 a share, 500 camels and 25 belly dancers... There is no recession, there is crushing inflation, there is a slowdown in mortgages, but please lets not call this recession.... That 75% of bankers did not know that finance ran because of leverage that's the real crime, that 25% of them who did know because they are the ones who created it, are now condemned becaue of one bad product (granted with xxxx billion$ of losses)is the real sadness...

Anyway that's it I am out, I deserve that table in Amika tonight, because unlike you all, I know this is a sham, there is no recession, and I am not going act otherwise...the boom times we created are here to stay, if you want to piss on the parade you go right ahead, I have an umbrella
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1*. http://www.bloomberg.com/apps/news?pid=email_en&refer=home&sid=ayIvmRwa4t6E

'The Big Picture,' a much respected site on capital markets has highlighted '100 years of DOW bull bear period chart.' It questions the possibility of another 'multi decade bull run' as historically unprecedented by comparing steepness of gains and subsequent post depression losses from 1924-1929 period to post .com 1996-2000 era...

.....Is it possible that an 18- year Bull market (1982-2000) could be followed by a 2-1/2 year Bear (March 2000 peak to October 2002 low), and then launch into another multi-decade (2003-2018) Bull? Sure, anything is possible. But as the chart above plainly shows, it would be historically unprecedented.......1

Comparing the steepness of rise in 1924-29 to 1996-2000 is comparing apples to oranges. This is quite a broad-brush treatment of Dow 100 year charts. Even if one discounts the GDP/capita and population increases, in addition to technological advancement, death of distance, and huge globalisation, this interconnected world is a different world from the 1924-29 gold-backed straitjacketed economy era. (in 1930 there was no Bernanake put)

One needs to look at the phenomenal change in the total world real GDP (Billions of 1990 International Dollars) in 1900 of 1.102 trillion$, in 2000 to 38.80 trillion$, and rise in global population in 1900 from 1.6-8 billion to 6.2 billion in year 2000. Companies like Google, Microsoft could not be created in 1924-29. Dow capitalisation in its last 100 years of steep rise takes into account most of the unaccounted capitalisation of the World Economy, 1-2000 AD.

Angus Madison, Professor of Economic Growth, in his recent book Contours of the World Economy, 1-2030 AD: makes these observations:

… From the year 1000 to 1820, growth was predominately extensive. Most of the GDP increase went to accommodate a four-fold increase in population. The advance in per capita income was a slow crawl – the world average increased by half over a period of eight centuries. In the year 1000, the average infant could expect to live about 24 years. A third died in the first year of life. Hunger and epidemic disease ravaged the survivors. By 1820, life expectation had risen to 36 years in the west, with only marginal improvement elsewhere.

Dow charts in the last 100 years had a lot of catching up to do with the under performance of last 2000 years.

Furthermore, 'The Big picture' argues with the help of '100 years of DOW bull bear period' chart that post- depression market took 25 years for Dow to regain its 1929 levels, it may take quite some time for Nasdaq to see year 2000 highs.

...... One other thing worth noting: The steepness of gains from 1924-1929 are very much parallel to the 1996-2000 moonshot. Both ended with near 80% drops (Dow for 1929, Nasdaq for 2000). It took 25 years -- until 1954 -- for the Dow to regain its 1929 highs. I don't believe it will necessarily take that long for Nasdaq -- but I am aware of the outside possibility.......2

Nasdaq may not see those highs for some time, but Dow and S&P have made new highs very recently. Whichever way one observes the vertical spike at the end of the chart, 'World GDP/capita' is astonishing. The performance of the global markets is very consistent with the hockey stick chart of the global GDP/capita.

Historical comparisons of Dow with a total disregard of GDP/capita and population are quite erroneous. Rates of world population growth, estimates of world GDP per capita and market capitalisations since the inception of 'new economy' have a significant correlation. In 1990, global market capitalisation was 9 trillion $; it rose to 28 trillion $ by 2000. Despite the dot.com bubble burst where 7 trillion $ wiped out of Nasdaq, global market capitalisation stood at 51 trillion $ in Jan 2007 signalling that globally the bull had never really died. Dow is trading at 110-115% of the GDP. Historically, it is said that 60% of the GDP is the right level for market capitalisation so perhaps it can be argued that 5 trillion$ can be wiped out of US markets so that historical average may be respected. However, in 2003, Dow market cap was 130% of the GDP and it still blasted off like a rocket until the credit crisis sell off.

Looking at Dow in isolation, no comparisons can be made to the trends of the past; year 1900 and year 2000 are not the same economies. So it is almost sinful to say it's different this time. Dow has to be seen in context of global progress on the front of productivity, death of distance, technology and induction of ex-communist economies in the mainstream global economies. BRICs economies bring new consumerism and Dow stratospheric graph needs to be looked and defined in that particular background too. The present markets have more to do with credit default swaps, and they are discounted far more than their underlying assets. There can be no comparisons; to make one is almost like economic war-mongering in global markets. And it is simply not good logic.

1.http://bigpicture.typepad.com/comments/markets/index.html
2.http://bigpicture.typepad.com/comments/markets/index.html

"Illusions commend themselves to us because they save us pain and allow us to enjoy pleasure instead. We must therefore accept it without complaint when they sometimes collide with a bit of reality against which they are dashed to pieces." ~ Sigmund Freud

In response to Kent Thune queries on when is illusion good? Is everything an illusion to some degree that can not be avoided? Does our perception become distorted as we age? Does that mean that we create illusions by "filling in the gaps of missing information" with our learned perceptions? Is it simply easier and more convenient to see something that is not there because the alternative (reality) is less pleasing?

http://financialphilosopher.typepad.com/thefinancialphilosopher/

One thing that strikes me is the 'meager value' of wealth that we pursue. The 'form of capital' today is a great illusion. The way huge amounts of wealth move from one place or party to another via a few 'cyber specks' is an uninterrupted illusion. Markets are efficient in destroying wealth and excess. A thousand, a million, a billion or a trillion - these are all in cyber space. This movement is unique, enabling people to be crafted from billionaires to paupers. Note here that an almost- millionaire is a pauper vis-a-vis a billionaire. BSC ex-CEO, Jimmy Cayne, sold his 5,658,591 shares on the 25th of March at $10.84. This was his total position of full common stock at BSC. At the high of the year, the value of his stake was about a billon$. At $10.84 it was $61.33. The wiping out of $950m of wealth is remarkably effortless.

Time and leverage are of the essence in the illusory world of today. Any individual, corporation or nation can go through the extremes of this illusion if they understand that the limits of their mathematical models are bound to fail at some point or another. Illusions surpass limits of mathematical models. John Merewether's efficient Market Hypothesis failed as it was based on assumptions, that the markets have become more efficient, hence the disaster LTCM. Particularly, the uncertainty associated with riskier assets has decreased, and therefore spreads between riskier and less risky assets should decrease. The fund, comprised of $140 billion in assets (almost all borrowed), had more than one trillion dollars in exposure through derivatives. Today's ABS and subprime crisis arises out of a similar genre.

A billion today is rarely ever physically transferred. In actuality, it has no physical presence. It comes easily and disappears into thin air. It is this 'illusion' that MER, C, BSC, JPM and MS now have to live with. Asset valuations are mathematically capitalized in 'cyber specks'; although this illusory cyber wealth is backed by physical assets, the ease of destruction of 'cyber wealth' is mind boggling. It leaves no charred grounds, no ruins. Physical wars against semi-developed nations are soon going to be meaningless. Once cyber credit disappears, nations go bust. If Afghanistan or Iraq were a cyber connected economies, for example, the shape of war would be very different. The 'loss of cyber speck dominated wealth ' can change the lives of people. It is far more destructive than physical war - it leaves no ruins but destroys people to the core.

Is it not a big illusion that a company like BSC gets smashed but its 1.2 billion glittering headquarters and its thousands of employees did not see any physical affect? Clashes in olden times left physical signs of destruction. In our illusion prone world, a man can be left penniless with no obvious sign of external destruction. Our present day global financial system is a system backed by illusory money – is this not a great illusion? 'Illusory money' has a destructive ability and its capability to obliterate the valuations of underlying physical assets is superior than any other method of obliteration. Those who handle this 'illusion' well (Goldman Sachs is a great example here) make money on both sides of the market.

Two books two different view points. I have highlighted book reviews by great critics, back to back reading of the two books yield two different view points and highlight the two facets of the debate, and I find them very educational, I would like to share the gist of the critics review with the community, for detailed dialogue do go to the links and study the reviews in detail, the links are highlighted below as 1 and 2. The critics have helped understand and appreciate the two positions far much better.

''The Black Swan''-The problem, Nassim explains, is that we place too much weight on the odds that past events will repeat (diligently trying to follow the path of the "millionaire next door," when unrepeatable chance is a better explanation). Instead, the really important events are rare and unpredictable. He calls them Black Swans, which is a reference to a 17th century philosophical thought experiment. In Europe all anyone had ever seen were white swans; indeed, "all swans are white" had long been used as the standard example of a scientific truth. So what was the chance of seeing a black one? Impossible to calculate or at least they were until 1697, when explorers found Cygnus atratus in Australia.1

"Capital Ideas" - In the early 1950s, graduate student Harry Markowitz presented his Ph.D. dissertation to the University of Chicago economics department. The response was less than encouraging. "This isn't a dissertation in economics," Milton Friedman told Markowitz. "It's not math, it's not economics, it's not even business administration." Whatever it was, Markowitz's heterodox theory of portfolio selection changed finance forever and earned a Nobel Prize.In recent years, however, some of these concepts have come under attack. Critics have argued that the academics used too many simplifying assumptions, such as ignoring trading costs. A school of thought, known as behavioural finance, has proposed that investors are not as rational as the models assume and are subject to psychological biases, such as a reluctance to cut their losses.2

''The Black Swan''-Nassim Nicholas Taleb is an essayist principally concerned with the problems of uncertainty and knowledge. Talebs interests lie at the intersection of philosophy,mathematics, finance, literature, and cognitive science but he has stayed extremely close to the ground thanks to an uninterrupted two-decade career as a mathematical trader. Specializing in the risks of unpredicted rare events (black swans), he held senior trading positions in New York and London before founding Empirica LLC, a trading firm and risk research laboratory. Taleb is a fellow at the Courant Institute of Mathematical Sciences of New York University where he has been teaching a class on the failure of models since 1999. His degrees include an MBA from the Wharton School and a Ph.D. from the University of Paris Dauphine. The authors ideas on skeptical empiricism have been covered by hundreds of articles around the world. Since childhood, Taleb has been obsessed with the defects of his own thinking. In addition to his scientific and literary interests, Taleb enjoys cafe lounging and museum hopping.1

"Capital Ideas" - Peter Bernstein "Just as Dante could not have understood or survived the perils of the Inferno without Virgil to guide him, investors today need Peter Bernstein to help find their way across dark and shifting ground. No one alive understands Wall Street's intellectual history better, and that makes Bernstein our best and wisest guide to the future. He is the only person who could have written this book; thank goodness he did."

- Jason Zweig, Investing Columnist, Money magazine

''The Black Swan''-The problem, Nassim explains, is that we place too much weight on the odds that past events will repeat (diligently trying to follow the path of the "millionaire next door," when unrepeatable chance is a better explanation). Instead, the really important events are rare and unpredictable. He calls them Black Swans, which is a reference to a 17th century philosophical thought experiment. In Europe all anyone had ever seen were white swans; indeed, "all swans are white" had long been used as the standard example of a scientific truth. So what was the chance of seeing a black one? Impossible to calculate, or at least they were until 1697, when explorers found Cygnus atratus in Australia.1

"Capital Ideas" - In his 1992 book, "Capital Ideas", Peter Bernstein gave a magisterial account of the academics' thinking. The likes of Harry Markowitz, Bill Sharpe and Myron Scholes developed theories to explain the link between risk and reward, the gains to be made through diversification and the framework for valuing financial options.

Financial historian and investment manager Peter L. Bernstein humanizes his saga of great shifts in financial theory by organizing it around eminent thinkers (Markowitz, Myron Scholes, Franco Modigliani, Robert Merton, Bill Sharpe and others, if you ever want to look up a finance guru). Deepening his analysis with insights from "behavioral finance," Bernstein describes how these innovators generated and extended the now-orthodox "capital ideas" of portfolio selection, capital structure, the Capital Asset Pricing Model, the efficient market hypothesis and the Black-Scholes-Merton theory of option pricing. Bernstein's erudition is dazzling, his explanations pellucid and his narrative filled with scintillating characters.2

Now Mr Bernstein has returned to the fray with a new volume in defence of his academic heroes. Although he accepts some of the theories' limitations, he argues that the professors built the structure for today's capital markets. Modern investors are much more sophisticated in the way they think about risk, in particular separating the returns available from market movements (beta in the jargon) and managerial skill (alpha).

''The Black Swan''-Taleb goes way overboard in attributing everything to luck. He thinks MicroSoft beat out Apple just due to luck. Taleb does not consider that MicroSoft open system allowed it to mushroom while Apple locked itself into a proprietary corner. Also, according to Taleb both the rise and fall of Rome were due entirely to luck. But, Rome was best at developing military strategy and transportation networks. However, it eventually suffered from imperial overstretch.1

"Capital Ideas" - Financial historian and investment manager Peter L. Bernstein humanizes his saga of great shifts in financial theory by organizing it around eminent thinkers (Markowitz, Myron Scholes, Franco Modigliani, Robert Merton, Bill Sharpe and others, if you ever want to look up a finance guru). Deepening his analysis with insights from "behavioral finance," Bernstein describes how these innovators generated and extended the now-orthodox "capital ideas" of portfolio selection, capital structure, the Capital Asset Pricing Model, the efficient market hypothesis and the Black-Scholes-Merton theory of option pricing. Bernstein's erudition is dazzling, his explanations pellucid and his narrative filled with scintillating characters.

FIFTY years ago, the business of managing other people's money was very much an art not a science, and was largely a matter of finding someone who was privy to inside information. But during the 1950s, 1960s and 1970s, academics changed the study of what became known as portfolio management. They did so in the face of much initial resistance and scepticism from the industry.2

1.http://www.amazon.co.uk/Black-Swan-Impact-Highly-Improbable/dp/1846140455/ref=sr_1_9?ie=UTF8&s=books&qid=12068810
http://www.amazon.co.uk/Fooled-Randomness-Hidden-Chance-Markets/dp/1587990717/ref=sr_1_6?ie=UTF8&s=books&qid=1206881079&sr=1-6

http://www.amazon.co.uk/Black-Swan-Impact-Highly-Improbable/dp/1846140455/ref=sr_1_9?ie=UTF8&s=books&qid=1206881079&sr=1-9

2.http://www.amazon.co.uk/Capital-Ideas-Evolving-Improbable-Origins/dp/0471731730/ref=sr_1_1?ie=UTF8&s=books&qid=1206881290&sr=1-1

(An attack under the belt - when a man is down dont hit him; Fox is doing exactly that to CNBC's Cramer. I am angry and furious- in defense of a friend).

Via MediaBistro, we learn that Fox Business Network has bought ad space in the New York Times and the Wall Street Journal, poking fun at CNBC's Jim Cramer, and what he said about Bear Stearns, days before its collapse.

Its an embarrassing quote, but in all fairness to Cramer, he was advising the caller not to pull their account from Bear Stearns, and was not (as is implied by FBN) advising them to buy or keep BSC stock.

The tag line of the Fox advert is "Turbulent Times Call For A Credible Network." 1

Sticking ones neck out and offering an informed opinion is what 'analysis' is all about. To run this ad is in bad taste. It a classic example of typical 'Monday morning quarter backing', and is not an attempt at fair play.

I will draw your attention to the last word from the famous 'The Economist' on oil pricing. In an unequal display of great folly and stupidity they predicted with great spectacle 'low oil prices for foreseeable future.' They forecasted just before the oil took off like a rocket in 1999 that 'low prices will gradually put most such areas out of business-especially if cash-strapped Gulf states conclude that the best way to increase revenues is to boost production, which could drive prices from today's $10 to as little as $5.'

When I see oil hovering around 100$, at an average of 50$ during the last 5 years, my 'reservations' on quality of these front-page fairy-tales get further reinforced.

James Cramer has been asking the Fed for the last nine months to open the discount window. That may have created a bigger bubble but that call looks great with hindsight.

He has been both right and wrong on many calls. But he makes a call every day, and that is what differentiates him from those who are pouncing on him. Being neither here nor there is not an analysis and Fox does that more often than not. Those who are right today have been wrong since 1987; overstatement is part of the game. Look at Financier George Soros, who was just as downbeat after the 1987 stock-market crash as he is today, each time predicting a depression.

Predictions about past economic inflection points are highlighted in this weekend's Barron's.

''[Market strategist James] Finucane has long kept score, carefully cataloguing predictions made. He points out, for example, that Greenspan contemporaneously described the Long Term Capital collapse in 1998 as the worst crisis he'd seen in his lifetime. Time magazine wasn't being intentionally ironic when it called the ad hoc government group cobbled together to grapple with the 1994 Mexican peso crisis the Committee to Save the World.''

Forecasting history is not short of such frolics. Sometimes we are victims others we are perpetrators. The players need to learn the basic rule that the worst act is 'I told you so' or 'how wrong he was.' We all make our errors; lets just own up on them instead of basking in the glory of other peoples errors. I wish that Fox could have highlighted before BSC Chairman's announcement on liquidity disappearance that BSC was practically bust.

Overall BSC was salvaged without a huge loss to the tax payers. In the UK, BOE inaction due to ECB regulation led to ambivalence on the part of the BOE. Northern Rock's demise was not only shocking but left tax payers with a state guarantee of 78billion£. The Fed, through very assertive and active management, allayed that. Bravo.

In a rumour infested market, any institution can go under. We are facing threats from vandals who, for their profits, will start any rumour. HBOS, one of the strongest institutions, had a run based on such rumours. The day Cramer talked about BSC, the rumour mongers had not yet attacked the bank with their tactics. In this global market casino of ours, the Fed has finally carved a role of the 'house'.

The short players have just started realising that there is no way they can win form the deep pockets of the house. In the face of extreme rumours, even triple A's and B's can become illiquid and insolvent. It is no more about sub prime toxic debt. Rather, it is now about "mom and pop" normal mortgages' prime instruments that are being affected, and loans which were being normally serviced.

The likes of Soros broke the pound as they did one up on BOE. Today they are cross they were unable to pull a quick one with the Fed's Bernanke. Financial historians will write long analysis and sing praises for Bernanke interventionism ala Donald Tsang in Hong Kong during the Asean contagion crisis. Lets revisit the Asean contagion.

ASEAN countries believed that the well co-ordinated manipulation of currencies was a deliberate attempt to destabilize the ASEAN economies. Former Malaysian Prime Minister Mahathir Mohamad even accused George Soros of ruining Malaysia's economy with "massive currency speculation", an accusation which few economists took seriously. (Soros appeared to have had his bets in against the Asian currency devaluations, incurring a loss when the crisis hit.) The East Asian Financial Crisis was a period of financial crisis that gripped much of Asia at the beginning of the summer of July 1997. It raised fears of a worldwide economic meltdown, a financial contagion. It is also commonly referred to as the East Asian currency crisis, or locally as the IMF crisis. (wiki source)

The Fed has simply borrowed a page from the HKMA and Donald Tsang (then the Financial Secretary), who declared war on speculators. The Government ended up buying approximately HK$120 billion (US$15 billion) worth of shares in various companies. They became the largest shareholder in some of those companies (e.g. the government owned 10% of HSBC) by the end of August, when hostilities ended with the closing of the August Hang Seng Index futures contract. The Government started selling those shares in 2001. They made a profit of about HK$30 billion (US$4 billion). The Fed will make similar kind of returns very soon once the vandals are staved off; economies don't go into recession when consumers are around. The speculators will learn that.

Bernanke's interventionism is currently being frownded upon. However, financial historians will, in the near future, sing praises for this very internventionism. The last 7 days of Fed assertion has not compromised moral hazard. Rather, it has has strengthened public trust in the institution of state. Donald Sang was critized when he staved of speculators.

Today, Benanke will face the same criticism from the advocates of lassez faire. However, there is a time when any debt instrument can fail as a result of insolvency. There are times when even the best of instruments are discounted. The value of any debt instrument is the ability of people to service the instrument over its life. The ability of service has not been compromised, but the rumours could have taken the values out and brought the entire economy to a standstill. Usually debt instruments fail as a result of macro-economic failure. The speculators had hedged an inadvertant scheme through which they would have failed the economy though the failure of the instruments.

1.http://bigpicture.typepad.com/comments/2008/03/fox-business-gu.html

You can change your life if you control your mind, and exactly know what you want!!

Mystery shrouds the art of living, it is all about unlocking the lock of our mind

A family of 5 who are involved in CDO's, CMBS, ABS and real estate debt, these months have been extreme test of wits, one after the other the icon have fallen, the most terrible day was as BSC got under and Lehman was under threat of liquidation by the hedge funds, just a day before GS and LEH reaffirmed earnings. Surviving is an art and as this storm reduces its intensity to uproot, I would like to share with everyone a condensed version of how we braved it...

The toughest moments were when friends helped us out in the evenings with review of the day, drinking, eating and relaxing.

In nastiest of times like we had in the markets for last one month one thing helped me the most to survive, optimism over pessimism, destruction cannot be perpetual it is on construction and progress that human culture is based, as storms most likely has passed over, we begin a new era with new hope and new enthusiasm, but I learned few lesson that I will like to share. Complex markets can be dealt with more effectively if one keeps the focus right. Some simple unorthodox steps I follow to maintain semblance in my life..

1. Live within your capacity and try to seize the day

2. Maintain individuality & integrity

3. Nothing beats 'Knowledge without prejudice' it is the real Power

4. Love people around you, extend it and live with them

5. Avoid confrontation you cannot afford, just don't take them on

6. Never over leverage, the best of ideas shall fail (Murphy's Law)

7. Live within yourself and get the best out of you

8. Never let others define your morality, seek nirvana through love

9 Have a long view, never live with a short view

10. Excellence in whatever you do- give it your best shot

11. Say what you mean and mean what you say

12. If it is too good to be true it is probably false

13. Nurture your ambition to stretch limits of your capacity

14. Dreams are great but never let dreams take over

15. Realism is what life is all about be a realist

16. Unbridled ambition is recipe of self destruction, avoid it

17. Savor little things in your life, look forward to them

18. Share your happiness with those around you

19. Take responsibility of your actions

20. Don't believe in conspiracies

21. Low esteem destroys people so does false pride

Bull and Bear – the lines are blurred...

For an average trader the real day starts at nearly 1.30 in the morning as Japanese markets pick up steam and ends at 8.00 in the evening, just six hours into the close New Zealand is trading and with yen carry trade being unwound the pain never seems to end around the clock. The six hours are the real party time, the sun down time. Ask me would I like to live any other way, burning at two ends I would rather resign and burn to the end, life in the slow lane is not for me. The ecstasy never ends, the fatalities mount and profits search is like unending pursuit of Eldorado, seeing perfectly normal ex-bankers ganging up to bring BSC down one day and going after Lehman the other is just pure fun. These are new vandals at the door, beware! Have you seen the movie 'The Independence Day' aliens in search of resources, these hedge funds are in search of big profits and their ability to trade both ways have provided new stability to the global markets. Refined to death 'Shoot first ask questions later' is the new-fangled philosophy of the new age.

For a global man, the world has become one country, the 'borders' only exist in the minds of those who are still involved with banal tribalism and frivolous battles. Excruciatingly painful global markets point out to one direction that we are part of the global village and in this village, the problem of one country affects the others, those rich in commodities are flush with monies today, those like India rich in intellectual capital are having field days. Countries like USA are going through a steep deleveraging, excess are being cleared out of the system, as there are no free lunches, free monies made through structured, exotic and derivatives products are flushed and games of cyber numbers make everyone of us realise that how difficult it is to create these numbers how easy to see them evaporating at Godspeed.

Everyone is a bear and everyone is a bull, the chameleon like change of mind, strategy and approach is the biggest strength and threat to any institution or individual. The lesson is clear never over extend, if the leverage is 1 to 32 the call that makes 2 billion last year if reversed will make person a pauper overnight. That is the lesson BSC executives learned the hard way, but that is the surgical accuracy of cleaning the thrash out that makes 'Wall Street' the greatest circus in the world of money, where Wall Street goes there goes the world monies. Money like matter remains within the system, it never gets destroyed, if Soc-gen loses big on the other side of the trade is someone who makes it. Soc-gen loss is GS profit, BSC liquidation or takeover is JPM advantage, it is dog eat dog world and one has to be nimble and smart.

The instruments of short are far more lethal than instruments that help you go long. The capacity of ultra shorts, like SDS, DXD in drawing the last ounce of blood left in the bulls, is immense. A bull is a bear at the same time; those who in this august thread feel that a bull is never a bear fail to comprehend that GS made its monies from short on ABS.

A week last Tuesday the sophistication of bull-bear relationship can be well imagined that a hedge fund which bought a huge qty of 40 puts on BSC was borrowing from BSC to short them. Imagine borrowing a stiletto from your lover to plunge it in her heart.

GS and LEH earnings yesterday should have been much worse after 9 months of continuous bleeding of the financial sector.

XHB, XLF have suffered immensely to that extent as if US economy is in depression, not even a severe recession. The illiquidity of the CDO's, ABS and CMBS kind of paper is deeply discounted; all this is a sign of capitulation where market news takes far higher toll than it is warranted. But that very selling is what differentiates USA from Japan, where inaction can help linger a problem, whereas, ask-questions-later-shoot-first led the Fed to sell BSC at 2$'s to JPM. Later on it was evident that the price was far lower than what shareholders expected or deserved. In this kind of environment, the snap back rally of yesterday was just a sweet reminder of how low and badly markets have been discounted..

Commodities are higher for a reason: it is not that demand and consumerism globally have fallen off the peak, depression and disasters, also recessions that everyone loves, are based on falling demand. Commodity prices are high because a full 1 billion middle-class consumers have added on to the global scene from Latin Americas to India and China. BRICS are the countries who are commodity-rich, and need a lot of infrastructure development; they are loaded and ready to spend on basic amenities like power houses, roads and health. The master economies of the world and mature companies are set to take advantage; lower $ would mean they are more competitive than Europe.

Rising consumerism benefits USA the most. MCD's, Starbucks and Pizza Huts are products that these new billon consumers will add on to their diet; unhealthy it may be, but 'in' it is. This is considered as a sign of affluence.

A decade ago Greenspan used to worry about USA being an oasis of stability; the speech of irrational exuberance also contained that USA cannot be the last banker of resort to everyone from LTCM, to USSR to Latin America or the Asian debt contagion. Today, most of these sick economies are great possible customers of mature economies.

We are at the cusp of a huge move forward; the pessimists will keep distorting the mantra and demanding the 'death dance' and full capitulation, however, the only thing that will decide the fate of the markets or recession or the death of $, is new consumerism and new commodity rich countries as part of the global free trade, or they are behind the Iron curtain. The one thing I am sure about is that these new consumers are very much a part of the scene and are looking to buy on GOOG, buy the latest INTC 6th generation chips and are avid users of Facebook and everything that is western produced; the best advice they get for their infrastructure development is from the likes of BSC and GS or LEH. Mark my words - a bull is a bear and a bear is a bull. Those who will not be able to change colours and tie themselves with old school definitions will cry themselves hoarse; markets are for people who are optimistically poised and understand the full dynamics of global realties.

The ability of the market to punish excesses and exuberance mercilessly, and overnight, is the strength of this market. BSC's 9.4% shareholder turned from a billionaire to a pauper overnight – is this not what we all want to punish, those who make mistakes? And are we not addressing the fine print of moral hazard more than adequately? Now when these funds want to kill everything in sight, then comes the bank of last resort and takes those 'papers', which back the other nearly 99% of the American population's houses and they do not have exposure to 'ninja loans' or subprime problems.

Housing starts fell 0.6% in February and permits for new construction plunged 7.8% to the lowest level in 16 years. The housing report showed February starts were 28.4% less than the level of February 2007. Given that the enormous overhang in inventory is a huge part of the problem, this is, perversely good news. New Home Starts Building Permits Continuing to add to the supply in this environment would be sheer madness. Housing starts fell 0.6% in February and permits for new construction plunged 7.8% to the lowest level in 16 years. The housing report showed February starts were 28.4% less than the level of February 2007.

Lot of carry trades $/Yen has been unwound but yen at 96 with possible 0% rates on the horizon and still no consumer demand will be hard to appreciate any further.

Zeroes are zeroes, what difference does it make to a young SocGen trader?
By Iqbal Latif, Paris

Zeroes are zeroes after all. SocGen trader, Jerome Kerviel is not an anomaly. He is part of a global financial system where in every day, an average trader is in his mid-to-late twenties, who runs trillions of dollars of global money. There are two very clear kinds of bankers today – one is the "old school" 70s banker who has absolutely no idea of credit derivatives and associated risks, and the other is the "new school" banker who comes fresh out of college and paid millions in bonuses for his performance. These "new" bankers are hungry, arrogant, basking in self-glory and foolish. Nothing in life can replace the experience of facing a bear market and a bull market.

"Old-school bankers" are terrified of this "new breed" of traders because they do not understand the equity derivatives, or the sub-prime and other trading mathematical models. SocGen is considered one of the best in the world in this sophisticated area because of the strong engineering background. The best trading gadgets and specialists are the French or the French of Algerian descent because of their intimidating knowledge of engineering where they apply mathematical expertise to create innovative models, which the "old-schoolers" find difficult to grasp. This is what happened with Barings Bank in 1995. Nick Leeson was untouchable at his desk. Last week I had dinner with a group of bankers. The average young trader was a 24-year old with $2 billion outstanding positions on sub-primes looking at how to settle. He had no idea. It is a typical story of a banker who leaves the capital of the bank in the hands of kids with great mathematical minds but no idea of a bear market. And they party hard, drive their Lamborghinis and Porsches, drink the best champagnes, and spend £15-20,000 on the table. They seem to be competing with the footballers in terms of spending money hedonistically. The old-schoolers, who are terrified of this unknown quantity, gained their experience and integrity in a proper learning curve, to become custodians of people's money. But they seem to be all gone now.

The point is that the old guards have to stop this one-way reverence and make sure that the proprietary capital of the bank is safe-guarded. In SocGen and in Barings scandal, there are very sharp similarities. The CEO, who was older and had no idea of sophisticated modern trading, allowed the hungry young traders to do what they did because they are afraid to lose them to other banks who pursue these hotshots like sharks, so no question was ever asked. These arrogant youths are the children of a bull market, in the bear, they run for cover and become fallen angels or scapegoats.

The young bankers of today, like Kerviel, who can lose nearly €5 billion (US$7.3 billion) as loose change, prove one point to us: Zeroes are just zeroes; they don't understand a hundred thousand, or a million, and not a billion. For them a loss is a loss; after five zeroes, the following trail of dots don't matter. Here there were nearly 10 zeroes after 5! The amount of positions he was running was around €40 billion, according to market rumours. On Friday evening, just before global black Monday, one of the compliance officers of SocGen found a trade which required a margin from the counterparty. The counterparty was called who said that this particular trade did not exist. All hell broke loose at 5:00 in the afternoon. The losses just multiplied, on the streets when others scented blood they drew it to the last pint.They leave the pint to leave SOCGEN as a walking dead.

It transpired that Jerome Kerviel was running a fictitious book with long positions on European indexes. There were no counter trades in these long stock positions settled in the books of SocGen; once you settle a trade, no liability arises. But Kerviel had worked in the back office for four years and had experience on the risk management system. He exploited that knowledge and was able to create his own fictitious book. But the point which arises is that every trade carried out on a trader's computer goes into the bank's hard disk and then to compliance. So the problem that begs the question is that SocGen, as a bank, says all its trades were matched properly and there was no exposure, then how is it possible that the compliance never got a confirmation from the counterparty? There are always two parties in a trade – the seller and the buyer. If he was the buyer of stocks in all European indexes, then he should have had a seller against a counterparty name. Did he create a fictitious counterparty too? It was not a mere million or €2 million but a whopping €40 billion-gross position in SocGen on Monday-Tuesday; the loss is around €5 billion. It is the mother of all losses in banking! Some say the positions were squared but even on volume alone it should have triggered all controls within the bank, how can a trader have neutral positions of 40 billion euros, was he churning. That should have been the first suspicion of the compliance.

It is impossible to accept SocGen's position at face value in that they did not have any inkling or indication until Friday afternoon that some of these runnings have parallel books with positions of such huge sums. It is not just about positions, but about the counterparty. In today's world, where know-your-customer policies have some kind of biblical importance, how could a fictitious book be run with fictitious trades and a fictitious counterparty?

Since August 2007, there have been grim rumours about serious problems with "one of the French banks" without naming names. The irony is that one of the most prestigious risk magazines in the UK have given an award to SocGen in January as a bank with the best-managed risks that serves its clients' interests in the best manner. As a tongue-in-cheek remark, I'd like to mention that whenever I meet serious bankers with their black-tie finery, shaking their heads in feigned modesty and accepting the accolades, I really wonder if they are aware of the fact that these awards are not being given away by Mr. Alan Greenspan, but by upcoming commerce-hungry news journalists who want to make a living by doling out these prizes and getting sponsorship and advertisement income for their journals.

Here another question comes into play: how many people are involved in this fraud? Is he a scapegoat? Analysis and forensic examination of the accounts will later indicate the truth as to why 6 of the seniors have left the same desk. It begs the question how a senior trader at his desk not be aware of €40 billion positions when Jerome was not even one of the stars of the bank; he was just an ordinary guy. Asset-backed securities, CDOs, derivatives, sub-prime loans, all these are very specialized fields. One error and you are down for the count. Markets are callous; they shoot first and ask questions later therefore we should be careful in what the media tells us.

A man who runs a €40 billion position on his desk, equal to the GDP of Bulgaria and Romania, or equal to 50% of Egypt's annual budget, could he be sitting for normal hours at the bank? He should be working 24-hours-a-day. To settle and square these fictitious positions would require a huge amount of input. So who was the manpower behind them? People go on leave, take coffee breaks, go on business lunches or dinners. The rumours were flying in August, a summer month where most Frenchmen take their vacation, then you have the Christmas and New Year holidays and holidays in January and February. Was this man not taking any leave? There is no doubt that the responsibility clearly lies on the senior management of the bank. There should have been lock-stock-and-barrel firing of the Board. The onus lies on them. This young man lost 7 friends on his FaceBook within two hours of discovery of the fraud. He is on the run, although this is being denied. He had a 6-hour meeting with the seniors where he explained his position. There was no personal impropriety.

Lessons are to be learnt from this latest scandal. One is that the Fed would never give a cut of 75bps if they knew what SocGen was upto on Monday and Tuesday. They erroneously thought that the fall-outs in the markets was the result of continuing decline due to sub-prime woes and gave the cut so there would be a lot of liquidity in the market to come back up. That was a blessing in disguise and a silver lining in the dark clouds. But perhaps the Fed overplayed its hand and gave us an extra 25bps more than required. In a way, Kerviel was not responsible for just a €40 billion loss; on Monday, €800 billion was lost in global markets' meltdown, as of today, all markets are back up to Friday levels. So the capital has shifted from the banks to SocGen who sold in panic as did other Asian banks to some hedge funds and investment banks.

I will not mention names but we all know who made the largest profits on the subprime. They made tremendous money out of the fallout. The other silver lining is that the world's financial system was put to a an extreme test, four times its performance design, not unlike planes that are put to a design test, but it came out, unlike the LTCM 1998 crisis which in comparison to this Monday and Tuesday is like a midget crisis. The ability of the Central Banks and the Fed to build financial institutions of the world on a day like Tuesday is unbelievable. So who is the net loser or winner? Money, like matter, does not disappear if the economy stays on course. Some banks and hedge funds have made huge sums by being short and others have lost their shirts.

One can say anything they want. Out of this calamity, one thing is proven: that the world financial markets are insulated. When we talk about a bubble and within a week 100% of the capital is lost, and regained, you wonder what bubble. Within a day when €800 billion is lost, and the next day markets rally and trade instruments as if nothing has happened makes it clear that the global financial markets do not allow the bubble to be pricked. On Tuesday, anyone who was buying Dow at 11,500 when it was down, after the Fed cut, could not buy anymore because there was nothing left to sell. I checked that Goldman Sachs was trading at 7 times its earnings at 79. So there are no bubbles. Only acts of God and human tragedies like 911 can bring the markets down. Financial issues are no threat because liquidity can be created by the central banks.

As SocGen declares results where entire year's profit is written off and they have gone for huge capital injection of €6 billion by the same banks who made billions in crisis from this bank, my advice is that times is of the essence and not on your side so keep a little liquidity, and to overcome any blip, make room for yourself. With the capital provided to SocGen by other banks, SocGen is a great buy at this level, so is Goldman Sachs – one is a victim of fear and the other king of opportunity. At the end of the day, capital shift of such magnitude is crown of the capitalist system. In this game of global finance, there are no victims and no winners.

I was brushing up on the geological time scale two days ago, and didn't find much on the web that placed the various eons, epochs, and eras on a timeline that was to scale. I'd like to say my goal was to place the history of economics on that backdrop, because that would make this exercise sound more relevant to this blog; unfortunately, it had almost nothing to do with economics, so I can't say that.

Like Y2k that was suppose to destroy the world, Avian Flu that was suppose to kill 100 million, and now a day's voodoo Global warming that is suppose to help accelerate the melting of the North Pole, sub prime is a new mantra of the 'prophets of doom' and the latest 'false tool' of doom and gloom .

Just go fast backward, in 2005 and 2006 it was all about impending recession and exploding deficits. One needs to be well aware of 'left-wing Keynesian economics' crying wolf for quite a long time.

On needs to know more about the historical propaganda of 'left-wing Keynesian economics.' Numbers involved in the sub prime issue aside the same cable of left wing liberals today make a mountain out of a molehill. Their 'guru' Paul Krugman (Op-Ed column) wrote in 2003 'for 20 months United States economy has been operating in twilight zone: growing too fast to meet classic definition of recession, but too slowly to meet usual criteria for economic recovery; says recent spate of optimistic pronouncements only show that things are getting worse more slowly; expects growth in second half of year to be faster than in first half, but not high enough to make jobs easier to find; calls this indictment of Bush administration's economic policy.'(3)

Donald Luskin their nemesis wrote a piece in Jan 2004 highlighting their errors of prediction.

In November 1982, when Krugman was a staff economist in Reagan's Council of Economic Advisors, he co-authored with Larry Summers (later to be Clinton's Treasury secretary) a memo warning of a coming "inflation time bomb." Krugman and Summers wrote, "It is reasonable to expect a significant reacceleration of inflation in the near future … A significant portion of the slowing of consumer price inflation since 1980 does not represent a reduction in the underlying rate." the "stagflation" of the 1970s — the combination of high inflation and low economic growth — utterly confounded the Keynesian orthodoxy, which would have predicted that such a combination was utterly impossible. Then in the 1980s the Keynesian model predicted that the combination of falling interest rates and Reagan's tax cuts should have created a massive stimulus to aggregate demand that would send inflation even higher. Yet inflation fell dramatically over the 1990s.

At that point inflation had fallen from a maximum of 14.6 percent in March 1980 to 4.5 percent. Its average for the rest of Reagan's presidency was 3.5 percent. The "inflation time bomb" Krugman predicted didn't go off. It still hasn't.

Please read this from 2004...

"When the curve inverts, run for the exits," said Smith, who served as an economist for the Fed from 1975-77. "It will stay that way until the Fed realizes it caused a recession in 2007. Investors should start planning for a recession."(2)

The Bush Budget Deficit Death Spiral
by Robert Freeman

Lenders talk about a "debtor's death spiral." It occurs when borrowers get so far in over their heads they begin borrowing money just to cover the interest payments on past borrowings. The borrowers have to do this to keep the lending flowing but they can no longer plausibly pay down the principal. As new debt compounds on old, bankruptcy becomes imminent. Further lending is foolhardy. Foreclosure is only a matter of time.

The U.S. is starting to look like it is entering just such a death spiral. It is foretold not simply by the large and growing deficits, nor by the fact that their carrying costs will rise quickly as interest rates rise. Rather, it is the fact that these trends are becoming irreversible, a structural part of the U.S. economy.

When the ultimate collapse will occur, whether it comes with a bang or a whimper, how it will be triggered, and how severe it will be are as yet unknown. But as Herbert Stein, Chairman of the Council of Economic Advisers under Richard Nixon was fond of saying, "Things that can't go on forever, don't."

The first signs of impending trouble are the exploding budget deficits themselves. They began, of course, under the parlous economic stewardship of Ronald Reagan. Reagan cut the marginal tax rate on the wealthiest of Americans from 70% to 38%. He promised it would spur an orgy of investment and rocket the economy to new levels of production and prosperity. Instead, his "supply side economics" did the exact opposite. It produced the deepest recession since the Great Depression. http://www.commondreams.org/views04/1022-26.htm>>

All the above have come out to be false.

With probably economic growth making the deficit disappear.

.''I think the deficit for fiscal 2007 will be a lot lower: $135 billion (i.e., a harmless 1.0% of GDP). I also see that if the current trends continue, the unified budget would move into balance in October 2008.'' (1)

Last fall Edward Lazear, the Bush administration's top economist, explained that what's good for corporations is good for America. "Profits," he declared, "provide the incentive for physical capital investment, and physical capital growth contributes to productivity growth. Thus profits are important not only for investors but also for the workers who benefit from the growth in productivity." Economic growth is a function of domestic demand and global demand, with 1 billion new consumers awaiting US products from China, Brazil, India , Russia we are looking at robust earning growth of technology unseen before. IBM block buster earnings in wake of low $ are an eye opener, INTC 1 billion connection drive based on connectivity, accessibility and education is at the cutting edge of bringing world together through American technology, the frontiers of US technology are today expanded from East to West, the sun most likely will not set on unique leadership of US technology.

Steep corrections in the markets will happen, lot of hue and cry will be the order of the day that is how markets operates and corrects its 'inbuilt efficiencies' and overdrives. The great meltdown leading to sell downgrades of GS, MER or JPM based on these limited downgrades of unrated debt is a sharp overreaction. Subprime as a percentage of debt is already a unrated debt, the diversions of the corporate yields point to long standing market practice of shooting first and asking questions later, market is efficient and will deal with the problem and excesses in the best possible manner. Underlying this strategy is the fact that overall 'growth' begets more growth and cash settles most of the problems of corporate excesses. The CDO graph represents a picture where nearly 15% or even less forms the 'toxic waste portion, the one which is not investment grade. Now if we see the total market of CDO's at 503 billion $'s, and even the whole 15% of the toxic waste defaults we are here looking at 80 billion $ say 100 billion $ spread as follows...

32% Banks and brokers... Equals 32 billion $
22% Asset managers..... Equals 22 billion $
19% Insurance.......... Equals 19 billion $
18% Pension funds...... Equals 18 billion $
10% Hedge funds........ Equals 10 billion $

In a world where monetary assets have grown to 145 trillion $, the amount of 'toxic waste portion' of CDO's as a proportion is very negligible and forms anyway the riskiest part of the CDO universe and well provided for. Those who will suffer loss will be the ones who have an inbuilt appetite for larger risks. The markets being primed for efficiencies take their own toll, sensationalism and herd mentality will take its due course, whoever said it is easy to make money through pyramids of leverage.

(1)
http://www.optimist123.com/optimist/2007/07/deficit-watch-j.html

(2)
http://seattletimes.nwsource.com/html/businesstechnology/2002717303_bonds03.html

(3)
http://www.nationalreview.com/nrof_luskin/kts200406141035.asp

Friday, July 06, 2007

There is an interesting article in July Bloomberg Mag ("Toxic Debt")about who owns the CDOs and CMOs now causing so much trobule at Bear Stearns, and possibly elsewhere.

Here is a short excerpt:

"Worldwide sales of CDOs—which are packages of securities backed by bonds, mortgages and other loans—have soared since 2003, reaching $503 billion last year, a fivefold increase in four years. Bankers call the bottom sections of a CDO, the ones most vulnerable to losses from bad debt, the equity tranches. They also refer to them as toxic waste because as more borrowers default on loans, these investments would be the first to take losses. The investments could be wiped out. . .

Because CDO contents are secretive, fund managers can't easily track the value of the components that go into these bundles. "You need to monitor the collateral in your investment and make sure you're comfortable there will be no defaults," says Satyajit Das, a former Citigroup banker who has written 10 books on debt analysis. Most investors can't do that because it's extremely difficult to track the contents of any CDO or its current value, he says. About half of all CDOs sold in the U.S. in 2006 were loaded with subprime mortgage debt, according to Moody's and Morgan Stanley. Since CDO managers can change the contents of a CDO after it's sold, investors may not know how much subprime risk they face, Das says."

Something is amiss here. The CDO graph represents a picture where nearly 15% or even less forms the 'toxic waste portion, the one which is not investment grade. Now if we see the total market of CDO's at 503 billion $'s, and even the whole 15% of the toxic waste defaults we are here looking at 80 billion $ say 100 billion $ spread as follows..

32% Banks and brokers.. equals 32 billion $
22% Asset managers..... equals 22 billion $
19% Insurance.......... equals 19 billion $
18% Pension funds...... equals 18 billion $
10% Hedge funds........ equals 10 billion $

A little detailed analysis of news like Wall Street Fears Bear Stearns Is Tip of an Iceberg and CDO Hedge Funds = Enron ?and Who else is sitting with all of this toxic debt? You'll be quite surprised to see The Poison in Your Pension one may discover that based on the charts and info provided so far, the case of a major crisis is far over blown.

BSC Hedge fund has already taken a 3 billion $ hit, many others have closed shop and gone belly up. In all likelihood the toxic waste of CDO risk is very well spread amongst institutions and amounts to from information so far to be manageable 'loss.' Most likely it may dawn that there might be after all no contagion. In a world where monetary assets have grown to 145 trillion $, the amount of 'toxic waste portion' of CDO's as a proportion is very negligible and forms anyway the riskiest part of the CDO universe and well provided for. Those who will suffer loss will be the ones who have an inbuilt appetite for larger risks. The markets being primed for efficiencies take their own toll, sensationalism and herd mentality will take its due course, who ever said it is easy to make money through pyramids of leverage.

http://bigpicture.typepad.com/comments/2007/06/who-owns-troubl.html#c75077132

Alone I stand in the autumn cold
On the tip of Orange Island,
I see a thousand hills crimsoned through
By their serried woods deep-dyed,
And a hundred barges vying
Over crystal blue waters.
Eagles cleave the air,
Fish glide under the shallow water;
Under freezing skies a million creatures contend in freedom.
Brooding over this immensity,
I ask, on this bondless land
Who rules over human destiny?

----Mao Zedong (1925)

Iqbal Latif- Paris

If Mao would have asked this question from his grave today the answer he would get be China! Exactly the way he wanted. However the path through which China has reached this success is contrary to his theories and prophesies.

Cash is king – Blackstone IPO made immense news on the markets. China's recently established Foreign Exchange Investment Company made the investment in the form of nonvoting common units of Blackstone (BG.UL). China announced in March it was setting up a vehicle to diversify part of its $1.2 trillion of foreign exchange reserves to improve returns and decrease risk. State media have said the new agency could manage up to $200 billion, although some Chinese economists have called for twice that amount to be at its disposal. "If we are going to borrow from them, then we have to let them buy things," said William Overholt, director of the RAND Corp's Center for Asia Pacific Policy.

China with over a trillion dollars sitting on its exchange reserves has launched a new invasion from the East. The new free traders from 'The East' stipulate no paramountcy, no fealty but only a secure sheltered home for their new found wealth of over trillions of dollars. Blackstone's newly appointed China chief Antony Leung, who was financial secretary of Hong Kong from 2001 to 2003 led New York-based Blackstone to set up shop in China. The price of the privilege for the defeated under Mongol invasions was the mass-sacrifice of their native aristocracy and the export of their treasure to their coffers. The Blackstone IPO -- dubbed by some the "Wall Street event of the year" -- is off and running. After pricing at 31 dollars per share, trading opened Friday at $37, and closed at 35.07. The Day's Range: 34.25 - 38.00. Chinese have announced their arrival on world global markets with a bang. They negotiated a huge discount of 4.5% on initial price offering Chinese and than took a big stake of $3 billion dollar in the private equity giant. Chinese made upwards of $500 million on day one, based on 100 million at $29.6 closing at 35.07.

Much of China had fallen under the Mongols' sway, and, far to the west, the sultans, the Caesars, and the throned dynasts of Europe trembled at the approach of Mongol hordes the strange and fierce Asiatics. They were first of the great free traders, and meritocratic, suborned peoples, of all creeds and cultures, were permitted to conduct their affairs autonomously — so long as they recognized Mongol paramountcy. Mongols sportingly offered enemies a choice: surrender or die. If they decided to fight, the khan was as good as his word, and they died — all of them, men, women, and children — but those who elected to pay fealty to the conqueror lived in peace under Mongol protection.

In today's world invasion from 'The East' works the other way around. Chinese have accepted limited voting rights and no right whatsoever to elect Blackstone's general partner. Probably the generous discount was based on this waiver from imposing decisions on the Blackstone board. In other words, while China may stand to make a profit on its investment, it doesn't get much control on how the company is managed in return for its money. Invaders of today are exporting their treasures and empowering the native aristocracy. Albeit much to the chagrin of the financial experts like FT's Plender who worry on the risks that such unaccountability creates on the corporate governance standards. If management is not answerable to shareholders needs what else will stop management to uphold basic principles of good corporate governance. The risk, writes Plender, "lies in the threat these flows pose to high corporate governance standards in the developed world."

China's bold positioning in one the bluest of the private equity firm buried the notion of China as the icon of successful model of Marxist socialism. The 1949 Chinese Revolution was an amazing episode of human history not only for the Chinese but for the rest of humanity, as well. The 1917 Bolshevik Revolution in Russia put on track an international competition for the hearts and minds of people all over the globe, the Chinese revolution raised the stakes by providing than 1/5th of humanity as canon fodder for the new revolution. The intelligentsia in the "West" defined this struggle as between "capitalism" and "communism." China's leadership rarely ever claimed to have 1949 Revolution as a communist revolution. China's leaders were members of a communist party like Bolsheviks, but never claimed to erect communism. They wanted a society that would be based on Socialism and it would be an intermediate stage between capitalism and communism.

Involvement in the Blackstone IPO is the concrete sign of huge transformation of Chinese emerging as a new benevolent capitalist of the world. This is the culmination of Deng instigated reform in 1978. Mao Tse-Tung termed "capitalist roaders" who he argued existed within the ruling Party structures and would try to restore the bourgeoisie and thus their class interests to power reflected in new policies, while only keeping the outer appearance of socialism for legitimacy purposes. Deng Xiaoping was identified as one of these "capitalist roaders" during the Chinese Cultural Revolution, when he was placed under house arrest. Mao had a great foresight he identified the abilities of Deng very precisely.

China is reeling from the battle of the graves between the Mao and Deng era. 30 years on though Deng beyond his grave has triumphed and 30 years on his policies have altered the course of the Chinese economy. Leading 'capitalist roader' as he was termed left a legacy that is far more entrenched than the failed 'Great Leap Forward' or Cultural Revolution. The Great Leap Forward is now widely seen, both within China and outside, as a major economic disaster, effectively being a "Great Leap Backward" that would affect China in the years to come. The official toll of excess deaths recorded in China for the years of the GLF is 14 million, but scholars have estimated the number of famine victims to be between 20 and 43 million. Mao saw grain and steel production as the key pillars of economic development. Mao forecasted that within 15 years of the start of the Great Leap, China's steel production would surpass that of the UK. That was never to be under state controlled enterprise, it has happened now as of today China has almost doubled its exports to become the largest steel exporter in the world at nearly 52 million tonnes followed by Japan, Russia, Ukraine and Germany. Production of crude steel for the 67 countries reporting to the IISI totals for the first 4 months 2007 was 428.4 million tonnes, China, accounted for 36% of world production in the first four months of 2007. Against China's 160 million tonnes UK production in the 4 months totalled to paltry 4.8 million tonnes. Mao would be turning in his grave today. The forced entry of 130 million farmer families into communes and ravages of Mao's excesses are now all part of forgotten past. Here we see today a rejuvenated country that is in all definition a capitalist economy.

Chinese investment in Blackstone IPO cannot be termed only as an opportunistic portfolio diversification, it is death of the Marxism socialism and it finally an élan vital of a mass conversion to capitalist system. Without sounding too dramatic the event in its after effects and far-reaching impact is no less than overnight fall of the Soviet in 1990 or the fall of the Berlin wall. The investment in Blackstone IPO is just the first trickle in an oncoming flood of money from developing nations sitting on huge reserves of foreign currency that are looking for better returns, but won't push for influence in how the companies they buy into are run. If capitalism needs an icon like the Roman churches for Catholics or Iran under Ayatollah, capitalism can hardly ever be better represented by the likes of Blackstone. A global business with 86 investment professionals and offices in New York, London, Mumbai and Hong Kong, they are the world leader in private equity investing, managing five general private equity funds as well as one specialized fund focusing on communications-related investments. From an operation focused in Blackstone early years on consummating leveraged buyout acquisitions of U.S.-based companies, with approximately $33.1 billion of assets under management.

China with over a trillion dollars sitting in its exchange reserves invests $200 to $300 billion a year in US assets, so far these investments earn the going rate of 3 to 4 percent for US treasury bonds. Chinese seem to agree with Charles de Gaulle on the alleged ability of the US to force the world to accept dollars and a low return on dollar-denominated securities because of the dollar's key currency status, a strong tradition of protecting private property, and its place as a safe haven in a stormy world. Why this should bother anyone?

In an essay in 1999 titled 'Capitalism, Socialism, and the 1949 Chinese Revolution: What Was the Cold War All About?' Satya J. Gabriel raised questions like Is the transformation taking place in China likely to alter the social relations on the planet in such a dramatic fashion as to inaugurate a distinctly new epoch in human history? If so, what are the dimensions of this sea change? What new algorithms will arise in the human family? And is it inevitable or are there possible obstacles that could block this transition and lead global civilization down alternative paths?

Today we see some partial answers to all the queries as reports of Chinese emerging as not only major equity and debt players but showing telltale signs of a strong capitalistic economy biggest gas guzzlers as in the first five months this year, China's net oil imports roared to 65.83 million tons, an increase of 11.5 percent from the same period last year. China has overtaken the United States as the world's biggest producer of carbon dioxide, the chief greenhouse gas, figures released. China's recorded emissions for 2006 beyond those from the U.S. It says China produced 6,200 million tons of CO2 last year, compared with 5,800 million tons from the U.S. As China enters in the world global capital markets as a responsible player and emerges as a new responsible economic player with in the global community. China, whose gross domestic product growth is barrelling along at a sizzling 10%-plus, and whose stock market, as measured by the Shanghai Composite Index, is up 56% this year following a 130% surge in 2006. With performances like this China definitely poses new questions on the permanence of the new global integrated markets. Alan Greenspan, made headlines with his warning that "the rally in Chinese stocks is 'clearly unsustainable'" and that "there's going to be a dramatic correction at some point." What impacts Chinese slow down will have on the world and its ability to export price stability or continued low inflation are the new questions that global economy is now looking answers for. Does a China face a future like Japan, wherein 80's the asset bubble created a national debt that has not until yet able to ignite domestic demand. The 'carry trade' of today is the remnant of that bubble induced slow down, if Greenspan is right, and the bubble burst killing indigenous demand and leaving China with huge loans the next generation of entrepreneurs world over might benefit from 'Yuan' carry trade instead of 'Yen' of today. What a great epitaph of Mao's land the savings of Chinese helping finance the consumption spree of global capitalism.

Dimensions of this sea change are immense and definitely these events are modifying the societal dealings on the globe in such a spectacular manner as to initiate a markedly new aeon in human history.

In the current issue of FORTUNE magazine, Tom Gardner, CEO of The Motley Fool and bestselling investment author, outlines six demographic supertrends that could power certain industries to sustained market out-performance over the next five years.

According to Tom Gardner, CEO of The Motley Fool 'One of the very best and very worst approaches to investing is to "play the trends." This sort of pure momentum investing is flourishing among hedge fund managers, whose one-year-bonus models lure them into very hot stocks in very sexy industries. It will not end well for their shareholders: The most efficient way for an investor to fall headlong from prosperity into poverty is to buy shiny objects at their highest prices. But patiently investing in long-term demographic trends will set up your portfolio for sustained super-growth. You won't be rewarded for it day by day. You will be buying forgotten and unforgiven stocks during painful industry downturns.'

The Trend: Home entertainment
Dolby Laboratories

This past holiday season, one out of every four gifts was a consumer electronics device, and spending in the category topped $21 billion. The industry has prospered over the past decade, in large part because you and I want to transform our living rooms into Cineplex Odeons, complete with six-foot-wide flat screens, surround sound, and the full integration of PCs, iPods, Wiis, TiVos, and DVD players. To my eye, there is no cle ar end in sight to this trend. Video-on-demand is just around the corner, and consumers will enjoy an embarrassment of programming riches via the Internet. Poised to benefit from each of these innovations is Dolby Laboratories (DLB), primarily a licensing business of superior audio technologies. After dipping 40% from the IPO price in 2005, shares have more than doubled, to around $34. A recent stock sale by founder Ray Dolby has scared off some investors - but not me. The company's balance sheet sparkles, and demand for its innovations should drive growth rates in excess of 20% per year. I think the stock will more than double over the next five years.

The Trend: Rising oil prices
Unit Corp.

The price of oil has risen more than 60% since 2004, and I believe that consumers waiting for a permanent price drop have lost their senses. Look no farther than Asia for the explanation. By 2010, China is expected to have more than 250 million middle-class citizens, who will whiz from Shanghai to Beijing to Chengdu in automobiles (let's hope they're more fuel-efficient than the guzzlers we've been driving). Someday America will not be the largest energy consumer in the world, and on that day oil prices will be far higher. For further context, please note that, adjusted for inflation, oil prices today are actually lower than they were in 1981. Moreover, gasoline prices around the world are on average twice what they are in the U.S. As entrepreneurial capitalism continues to cover the globe, the demand for petroleum will only rise. Unit Corp. (UNT), a contract driller operating primarily in Oklahoma and Texas, is perfectly situated for sustained growth. It is one of the 10 most highly ranked stocks by our Motley Fool community. Here again, I think you're looking at more than a double over the next five years.

The Trend: Eating out
Middleby Corp.

Although Americans are staying home for movies, we're eating out like never before. In 2007 we'll spend more than $550 billion devouring food prepared by someone else. This trend has risen steadily for the past 40 years, accelerating of late in part because more than 60% of mothers now work outside the home. The net result is a flurry of new restaurants - numbering 900,000 in America - in the categor ies of fine dining, fast casual, family dining, fast food, and self-service. One company that's benefiting across the board is Middleby Corp. (MIDD). Its stock is down 15% from highs this year but has risen more than 20 times in value since 2000. Middleby has emerged as the leader in sales of innovative, high-quality, and energy-efficient ovens to restaurant chains. What's particularly appealing here is that the same shift in eating habits are playing out internationally, only with far more upside. And Middleby is well positioned to profit around the globe. I believe this stock also will more than double over the next five years.

The Trend: Homebuilding
MDC Holding

Without question, homebuilders are the most reviled stocks on Wall Street today. Year over year, building permits are down 28%, building starts are down 16%, and foreclosures are up 35% natio nwide. The sentiment indicator of the National Association of Home Builders is at a 26-year low. Shares of one residential construction company after another have fallen at least 40%. So, you may be thinking, why the hell should I buy a homebuilder stock today? For context, page back to 2002, and recall how Internet stocks had been dragged into the town square to be kicked and spat upon. Valuations had collapsed, weak companies were folding en masse, speculators had capitulated. At the height of that calamity I had a memorable conversation with world-class money manager Marty Whitman, founder of the Third Avenue funds. He emphasized that at the core of most bubbles is a kernel of commercial truth that will eventually expand. He cited example after example of Internet-based businesses valued at less than the cash on their balance sheet, tagged with expectations of eternally negative growth rates. Whitman counseled in 2002 that it was a wonderful time to buy those stocks, since Web-usage statistics were strong. He was dead on. I believe similar dynamics are at work in the homebuilding industry. The Census Bureau projects that by 2050 our population will have increased by 50%, to more than 420 million. We'll also be a much older society, with close to half of all citizens over the age of 45 (compared with around 37% today). What that means to me is that there will be major construction, particularly of second homes, in the Southern states. One beneficiary will be MDC Holding (MDC), a homebuilder focusing on states like Arizona, Texas, and California. Accounting for dividends, MDC has rewarded shareholders with 16% annual gains over the past 20 years, which includes the 40% shellacking the stock has taken since July 2005. I expect more than a double through 2012 from MDC.

The Trend: Digital doctors' offices
Quality Systems

To date, less than 10% of American hospitals have implemented electronic medical record keeping as a core piece of their technology strategy for health information. The majority of primary-care physicians continue to scrawl out diagnoses and complete health-care transactions with paper and a No. 2 pencil. That's shameful. To me, there is no question that 10 years from now, our health-care providers will have embraced the digital revolution (at least a decade late!). Quality Systems (QSII) has the leading software package for electronic medical record keeping. With more than $80 million on its balance sheet, it also has the financial underpinnings to enjoy superior growth rates for years to come. This stock has already risen seven times in value over the past five years. I'm expecting more than a double over the next five.

The Trend: Alternative sports
Volcom

This trend makes for a great way to involve your children, grandchildren, nieces, and nephews in the joyful game of stock investing. Alternative sports in America are becoming less alternative every day, as young adults turn to more individual and outdoor sports for recreation. What's more, the number of girls participating in all forms of sport is radically higher than it was 40 years ago. That's another trend playing out across the globe. Sports like snowboarding, skiing, surfing, skateboarding, and mountaineering are gaining in popularity. One of the more compelling apparel companies on the market is benefiting from all this. Volcom (VLCM), the purveyor of apparel and shoes for outdoor enthusiasts, came public in 2005. A year later the stock was 30% below its offering price. Since then, it has more than doubled. The financials are excellent. The business is heavily owned by executive leadership. The CEO is an authentic leader. And I am expecting in excess of 15% annual returns over the next five years.