Friday, September 19, 2008

Questions In The Aftermath of the Bank Rescue

As details emerge regarding the government's proposed plan to assume toxic bank debt and backstop the mortgage and money markets, the estimates of the cost are quite high. How does such a massive assumption of debt affect perceptions of the dollar and the creditworthiness of the U.S.? How will it affect government borrowing going forward (and thereby interest rates)? How will it affect inflation? How will it compete for investment dollars with corporate borrowing? How will all of these affect economic growth in the U.S.? It's interesting to see that, with stocks soaring today, gold is moving higher (top chart); the euro is moving higher vis a vis the U.S. dollar (middle chart); and 10-year Treasury rates are soaring. Time to hedge U.S. dollar exposure?


Firebird said...

Dr. Steenbarger,

Regarding your post "Questions In The Aftermath of the Bank Rescue" and how this massive bailout will affect the dollar and US credit worthiness, I thought this chart would come in handy. Please notice how the dollar doubled (!) in a mere four years as banks were deregulated, allowed to own positions in real estate and allowed access to funds from the FED and how the dollar retraced the whole upward move in about the same time, effectively halving its value.

What both troubles and perplexes me is that except for a surge in the last couple of months, this time the dollar had already been steadily losing value over the last six years, so how low could/would/should it go? Honestly I'm at a loss here and still don't understand that it hasn't tanked already.

Incidentally, as a historical note (disclosure: no political position) it was George Bush Sr. who created the Resolution Trust Corporation in 1989, basically putting the slide in the dollar to a halt. W's brothers Neil and Jeb were involved with the S&L scandal, playing different roles. Neil settled out of court and his bank and Jeb were bailed out.

Two George (W) Bush's, two wars in Iraq, two wars in Afghanistan (on different sides) and two massive financial bailouts. Not to mention the Berlin Wall falling under Bush Sr.'s watch vs. Russia "invading" Georgia under Jr's watch. Reality surpasses fiction. (Speaking of coincidences, I was a exchange student in the US during both Bush's administrations,).

Further commentary or elaboration on the topic of your post would be greatly appreciated.

Best trading,


Mark said...

The dollar and the creditworthiness of the U.S. are interesting questions in the aftermath of the Bank Rescue. The extra 100's of billions of dollars are not going to come from the American taxpayer or from selling more bonds (who will buy them?) so following the precedent of similar "impossible" situations I agree that it's likely to be printed - leading to higher inflation and a lower dollar. All Americans would then pay the price through the loss of value of their earnings and savings.

Club STC said...

Hi Brett

In solving the 'immediate problems' the FED is is creating insoluble(?) for the near future.

Since mid-August 2006, the US M3 has grown from 9% to 17% in March 2008. In August 2008, it was estimated at 14&.

All this without taking into consideration the billions to be spend on Freddie and Fannie, AIG and the latest efforts 'to save the US & world economy'.

It takes about 18 months for the M3 excess to be reflected in the CPI figures.

Right on cue, the June figures were the greatest increase in 26 years, the July numbers higher than expected and the August numbers in line with expectations. If you look at a chart of the CPI (headline and core), you'll see a steady uptrend.

Next year, with the elections out of the way, we can expect the CPI to rise exponentially as the effects of the earlier M3 increases are reflected in the inflation numbers.

What will the FED do then? Unless it wants wheelbarrows of money in the streets, it WILL raise rates at a time when the US economy is fragile.

The first quarter of next year, the US$ to resume its downtrend, and the bear market in stocks to begin with a vengeance. That's my call.

Unfortunately the excesses of US the FED will affect the rest of the world. So we are all in for a tough time over the next two to four years.

Keith Shepard said...

Wither the US taxpayer: a 1 trillion dollar war and a 1 trillion dollar bailout of the rich.

Brett Steenbarger, Ph.D. said...

Great comments, and I'm certainly also concerned for the dollar and the federal budget deficit. I find it interesting, however, that very few people are asking the question of what happens if the Treasury buys the bank bonds and makes a killing on them? That would be dollar positive, setting up a massive unwind of strength in gold, euro, etc. I like to play with "What if" scenarios to stay flexible in my thinking, even as I build hedges and protections from tail risk...