Reserve Bank of Australia and Bank of England to Cut Interest Rates

Foreign Exchange Outlook TreasSec Paulson’s once-bright image is now more than a little tarnished after his plan gave the appearance of an arrogant power-grab, leaving Fed Chairman Bernanke as the sole standing hero. Bernanke speaks about the economy tomorrow and everyone is waiting breathlessly until we hear what he has to say about further federal government bailouts of everybody from General Motors (Detroit already got a little-noticed $25 billion in last week’s bailout) to the states (California Governor Schwarzenegger already applied on Friday). As noted by many observers, it’s a little silly that a state--with taxing authority--can’t peddle its bonds, or that companies with raw materials and inventory can’t get a loan at a sensible rate.
The total lack of trust is what is gumming up the works, and nowhere is the lack of trust worse than in our inability to price credit default swaps. As perpetual bear James Grant said on “60 Minutes” last night, we don’t even know the face value of the market, probably somewhere between $50-65 trillion. Credit default swaps were invented as insurance against default, but not named “insurance” because then the contracts would have to be regulated by the insurance regulators, not to mention being put on balance sheets. This is the market Warren Buffett said was pure poison a few years ago. It is also the market that put AIG on the block to the Feds. Solve the credit default swap problem, and a lot of other problems go away. We have no idea how this could be achieved and at a guess, neither does the Fed-yet.

The Reserve Bank of Australia meets tomorrow and the Bank of Enlgand meets on Thursday, with both banks forecast to cut interest rates by 50 bp. The Fed meets Oct 28-29 and the ECB next meets Nov 6, but chatter is going around that the central banks could coordinate rate cuts or at least all cut by the same amount. As noted above, monetary policy has exhausted its capability to goose markets, but never mind—rate cuts are good for confidence because it shows the governments are not dithering. In fact, Market News reports that the Swiss newspaper Sonntag reported yesterday (without naming sources but claiming they are “independent and credible”) that the Swiss National Bank will cut rates 25 bp by December at the latest, and the action could come as a coordinated move with the BoE and ECB.

Other policy options, in the US at least, include promises to bail out just about anybody who asks, something the cartoonists have already latched onto. The problem is not whether this is “socialism” or against US principles-of course it’s against US principles-but how to fund it. The only people with national savings (reserves) are in the Middle East and Asia. These countries lack developed capital markets (not to mention the rule of law, getting a bit battered these days), and so we imagine that Paulson and others have already been burning up the phone lines to these countries asking for a form of petro-dollar recycling.

This was a big deal in the late 1970’s and early 1980’s as it became clear that countries with newfound wealth had no real place to stash the cash. This time we have Emirates building islands in the sea shaped like palm trees and skyscrapers going up in Shanghai, so opportunities to invest domestically are not as scarce as thirty years ago-but still not big enough or safe enough for all the savings.

Why should these people rescue us now? After all, we brought in on ourselves with over-spending and stupid math-based con games.

Well, it may be touch-and-go, but in the end, the mercantilist argument will probably win. These countries, from Saudi Arabia to China, are export-based economies. No exports, no economy. No exports, no revenue to buy off restive populations who have a newfound hankering for everything from indoor plumbing to a Mercedes Benz in every driveway. They will rescue us because it is their political self-interest to do so. But these people are very, very smart and can see that the price can be forced to a very high level. Buffett has shown the way and established a new benchmark for big deals-10% dividend plus equity options. By the time this is over, over half the US economy can belong to the Middle East and
Far East. No wonder Western companies are wooing suitors in Japan so assiduously these days.
And the US is out ahead of the pack with initiatives to fix the situation.

Citibank got a court to open up on a Sunday to press its case for Wachovia over a competing bid from Wells Fargo. This is crass, but imagine a court opening on a Sunday in (say) France. In Europe, Trichet said it all-“We are not a political federation. We do not have a federal budget.”

So if a Middle East sheikh or Chinese agency wants to invest in “Europe,“ where do they send the check? This is an echo of Kissinger asking what telephone number to dial when he wants to negotiate with Europe. Well, perhaps this crisis today will nudge Europe toward greater federation, but we wouldn’t count on it.

Finally, where is G7 or G8? It was supposed to meet at the end of this week. The only validity the group can have going forward lies in expanding G8, which already includes Russia, to include China, and perhaps Brazil. We assume the British would never agree to inviting India, and the US may baulk at Brazil. Maybe we need a new kind of organization altogether, once that negotiates directly with OPEC, say. The Group has become increasingly toothless and irrelevant. If it is to survive, it must act this week. For that to be effective, Europe has to act as a single entity on the financial crisis, too. Until the rest of the world gets its act together, the US Dollar exchange rate will continue to be favored, even though it can hardly be said the US is doing a good job. In fact, it’s doing a terrible job, but it’s showing it can do something, even if it’s wrong. Action is better than paralysis, politically. We like the US dollar this week, and we also like the yen, especially in the old carry-trade crosses. The commodity currencies will be the hardest hit, since global recession hits commodities first. And we still await word from china about what it wants from all this.

There is no solution without China.

Bye for Now

Barbara Rockefeller - Forex Trading Reports

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